The startup world is often seen as a dream world. To realize those dreams, capital is needed. That's where valuation methods and fundraising come into play. For both entrepreneurs and investors, this is a complex and challenging process. This process requires both art and science! I will take you through a number of elements that determine the complexity of valuing startups:
- Pioneering innovations: Determining a fair price for groundbreaking innovations is difficult because there are no comparable companies. This makes it difficult to validate a startup's strategy and determine an appropriate price tag. Pilot projects and beta versions can reduce uncertainty, but the actual launch can still bring surprises.
- No historical data: For startups, especially in the early stages, the lack of historical data is a major stumbling block. Without financial data from the past, it is difficult to make reliable predictions about important factors that determine value, such as growth, efficiency, and cost structure. This makes standard valuation methods such as the price-earnings ratio (P/E) or EV/EBITDA unusable.
- Achieving positive cash flow: For startups, it is difficult to become profitable. Their value depends mainly on future investments, not on tangible assets. It is already difficult enough to predict finances in the short term, let alone in the long term. And just like established companies, startups also have to take into account economic fluctuations and market changes.
- High dependence on people: Many startups are highly dependent on people with unique talents. For example, if a key product designer leaves, that can cause major problems for continuity. Finding an equally good replacement takes time and can disrupt operations. In addition, there is always a chance that the departed employee will return as a competitor.
- Looking for a bridge between dreams and returns: Founders are like dreamers, inspired by stories of unicorns and asking themselves: "If they can do it, why not us?" Investors see things differently. They look at the hard facts. Sometimes, when they hear such ambitious dreams, they think: "That sounds too good to be true."
- Complex structures and illiquidity: Even small startups can have complex capital structures with different types of shares, royalties, hidden costs, and performance-based bonuses. These differ per financing round and investor agreements. In addition, the lack of liquidity of investments in startups can lead investors to include a risk premium in the valuation, which widens the gap between the expectations of founders and investors.
- Flexibility is underestimated: In the dynamic startup world, value is often determined more by future possibilities than by the current reality. Investors often overlook that startups, thanks to their agility, are able to adapt strategies to demand and explore different channels. Traditional valuation methods, however, often do not fully take this flexibility into account.
Despite the challenges of valuing startups, Schuiteman M&A - Corporate Finance can help. We dive deep into figures, scenarios, and deal structures to provide valuable insights for investors, identify opportunities, and reduce risks.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.