Do you know how much your start-up is worth? Have you thought about how you would begin to value it, especially in a changing market? Understanding your start-up valuation is an important step in the funding process but determining how to do it can be tricky. Setting your benchmark, getting the right strategy in place and establishing a set of measurements that will future-proof your valuation is crucial.
Starting your valuation
The best place to start? Look to your MRR (monthly recurring revenue) and ARR (annual recurring revenue) in detail to give you a better benchmark of where your company is at and where it’s going to be in the future. flinder CFO Dave Eaton says, “If you’ve been growing year on year, try to reflect that in your valuation, then you can argue that you have this demonstrable value today and growth potential for the future.
For a SaaS business in particular, valuation is generally based on MRR and ARR – it’s the widely accepted mechanism. The heavy investment demands for SaaS businesses means NPV (net present value) type calculations aren't very relevant for early-stage businesses. What you do want though is to be really clear on is how you can justify a premium ARR multiple for your business. It might be that your growth rate is market-leading, you lock customers into long-term contracts or invoice and get paid for annual contracts in advance. All of these will differentiate your business and allow you to justify a premium valuation.”
However, when valuing fast-growth loss-making tech businesses, the valuation is mostly about the future revenue stream. If you’re pre-seed or very early-stage, it’s hard to value because there isn’t a revenue stream. In this instance, the valuation will have to come from a demonstratable proof of concept.
To some degree, your valuation can also be affected by how much funding you’re looking to raise. The general rule is that you should be looking to raise enough funding to last around 12-18 months before your next round of funding. “The reason for a 12-18 months runway is that realistically you’ll need to be on the fundraising trail six months before you’ll have new money in the bank, and you’ll need to show growth between now and then to get new investors interested. Any shorter than 12 months’ runway and it’s going to be hard to hit key milestones or show any real traction. That means you’re going to find it harder to justify a higher valuation at your next round. It’s called a runway for a reason – if you don’t have lift off before you reach the end, things will come to a sudden stop,” (How to value your company and how much equity to giveaway, Seed Legals, 2019).
Typically, seed investment rounds will take 10-20% of the company so factoring in the12-18 months runway required for the round, these two factors will drive the range in which your start-up valuation can sit.
What kind of benchmarking should you use?
Set your baseline by what other businesses do in your sector and use others in your ecosystem to justify your valuation. Your valuation and forecast parameters will most often be set by the market in which it operates. “The market multiple approach values the company against recent acquisitions of similar companies in the market. Let's say mobile application software firms are selling for five times revenue. Knowing what real investors are willing to pay for mobile software, you could use a five-times multiple as the basis for valuing your mobile apps venture while adjusting the multiple up or down to factor for different characteristics. If your mobile software company, say, were at an earlier stage of development than other comparable businesses, it would probably fetch a lower multiple than five, given that investors are taking on more risk,” (Valuing start-up venture, Investopedia, November 2022).
What kind of strategy should I take when determining my valuation?
Have a credible strategy. Your valuation and forecasts need to be based on a reasonable set of assumptions. You need to keep it simple and not overcomplicate it. CFO Dave Eaton recommends,
“See that the funding can payoff. Give visibility for the return on investment – make them understand that you’re able to execute your plans and get a return in a reasonable time frame.”
Set your future milestones along your business trajectory, make them realistic and easy to visualise. Equally, having a solid understanding of why you’re valuing your business as you are and a plan that makes sense to investors is important. Bottom line - you need to do your homework and come prepared when meeting potential investors.
What set of measurements should I be looking at to value my start-up?
You want your value to be increasing over time so there’s no point to go in with a valuation too high at the start. While every founder dreams of a high valuation, if your start-up valuation too high, it will create challenges to maintain that high valuation in the future and you run the risk of a down round. When using the metrics mentioned, ARR and MRR, you’re looking to demonstrate that your business is revenue generating, which will future proof your initial investment value.
Investors will be reviewing the milestones that have been set in your strategy and whether they’re realistic to achieve, how well you’ve met past objectives and how accurate your financial plans have been in the past.
Dave also advises, “Don’t do anything too silly or overly ambitious – I would say it’s one of the first things that would turn an investor off. You lose credibility when you attempt that and if successful, puts a lot of pressure on future rounds to avoid any down rounds.” Know that you need to have a justification for what valuation you are going for, be able to explain it simply and effectively. Keep in mind the future rounds of funding you will be making too, you don’t want to tie yourself into future plans that aren’t achievable in your current round of funding.