Ways to assess the value of start-ups abound

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Ways to assess the value of start-ups abound

Saturday, 06 March 2021 | Hima Bindu Kota

Ways to assess the value of start-ups abound

However, it is important that a venture capitalist or an angel investor also delves into the importance of human capital

The number of entrepreneurs increased manifold last year, making India a global start-up hub. The start-up story in India has seen a very encouraging growth with a vibrant ecosystem of incubators and venture capitalists, with total funding reaching the $70 billion-mark between 2014-2020.

Using the time series forecasting technique, Inc42 Plus has predicted that start-ups are likely to raise capital to the tune of $13 -$14 billion across  1,000 deals in 2021. Since new business ventures by entrepreneurs emphasise on launching new products or services using unique ideas or technologies, the methods to assess their value are also different.

 The ‘Berkus Approach’ is a technique given by the famous angel investor, Dave Berkus, wherein both qualitative and quantitative factors are assigned to every risk faced by a start-up on five elements: The basic sound idea; prototype; management team; strategic relations and sales.

Each element is assigned a monetary value as well, that can reach up to $5,00,000. So, a value is assigned between zero and $5,00,000 for each of the elements given above. For instance, a start-up with a team having high domain knowledge can be assigned a value of $3,50,000.

While, if a start-up has finished 45 per cent of the prototype, a value of $2,25,000 can be assigned to it. Similarly, an appropriate monetary value is allotted to each of the other elements to create a valuation of the new venture.

 The ‘Scorecard Valuation’ method is an extension of the Berkus Approach, where start-ups are compared with others of the same industry using the assigned values and then using the scorecard to arrive at the right valuation.

There are several elements involved in a scorecard like the quality of the management team; the type of opportunity; uniqueness of the product or service; competition; promotion and marketing; requirement of future investment and other similar factors.

A range of percentages is assigned to each element which also provides flexibility in valuation as all beginners will have different strengths in different areas.

 Another future-looking valuation technique is the future valuation multiple approach that evaluates long-term Return on Investment (ROI), usually for a period between five and 10 years.

The value of the start-up is based on the projections including sales and growth, cost and expenditure projections and similar data. Taking the ROI forward, the risk factor summation approach takes into account all the business risks that can have a negative impact on the ROI.

Some of  the business risks considered are management; political; obsolete technology; competition; manufacturing; investment; legal risk and so on. Once an initial valuation of the start-up is established using any of the valuation techniques, the impact of business risks is either added or subtracted from the initial value for a positive and a negative risk, respectively.

The ‘Venture Capital Method’ is one of the quickest approaches to value an early-stage company and is used by venture capitalists globally. This is calculated by using the exit value, the value at which any venture capital sells its portion of stock and exits a start-up and the expected ROI.

However, a drawback of this approach is that it does not take into consideration any future dilution.

 Another approach that can be used is the cost-to-duplicate approach that takes into account all costs and expenses associated with the start-up, including the development of its products and the purchase of any physical assets.

It requires a high level of due diligence and is also the most practical. One of the major drawbacks of this method of evaluation is that it fails to take into account any future potential of earnings and growth. It also fails to recognise the impact of intangible assets, like brand value, goodwill and patent, on the valuation of start-ups.

The discounted cash flow technique uses a suitable discount rate to find the present value of the future cash flow of new businesses. Since the start-ups are generally considered high risk for investments, a higher discount rate is applied for calculating the present values. A market multiple approach is one of the most popular valuation techniques where a base multiple is calculated based on the worth of any recent investment in a start-up in the same industry. The business in question is then analysed based on this base multiple.

So, there are numerous valuation techniques available to value any start-up. No one technique is superior to the other. A slight change in technique can change the perception about investing in new ventures.

Overall, the monetary aspect is just one side of valuation. It is also important that a venture capitalist or an angel investor delves into the importance of human capital.

The writer is Associate Professor, Amity University, Noida. The views expressed are personal.

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