Valuation Methods
Overview
Valuation of startup and emerging companies with most having negative cash flow in early stages with significant projected rewards later is very difficult task. Yet investors are confronted frequently with investments whose current value must be estimated in spite of the fact that much of the reward lies in future. This paper will discuss various methods used by investors to value such startups and emerging businesses. The latter half of the paper will discuss negotiation of term sheets and various different terms that are used by investors to ensure a successful investment, maintain value and control of the invested company as much as possible, share some risk with other investors and obtain maximum financial reward if the venture turns out to be a success.
Valuation Methods
Following are some of the most commonly used methods for valuation of startup and emerging companies followed by a comparative analysis of the strengths and weaknesses of each method. There are various different approaches to estimating the value of a startup company.
Income Approach: Estimating future cash flow that could be taken out of the business without impairing future operations. Most common methods in this approach are: Net Present Value, Equity
Cash Flow and Capital Cash Flow (Adjusted Cash Flow being a variation of this method).
Market Approach: Estimates the value of a going concern business by comparing to similar firms whose stock is publicly traded. In many cases Market Approach is used as a secondary valuation method to verify the estimates derived from the Income Approach.
Asset Approach: valuation based on the firm as a financial option.