It’s often difficult for early-stage businesses to assess how much they’re really worth. Below, we outline some methods a business owner can consider to conduct a sound valuation, which is a process used to evaluate the economic value of a business.
Four valuation methods are described below that are specifically geared towards early-stage businesses.
1. Comparable Transactions
An inherently extrinsic approach (the value of an item based on external factors), the comparable transactions method looks at recent valuations of similar businesses in the same industry. If comparable businesses have been recently sold or funded, the valuation of those businesses can serve as your initial negotiation benchmark. This valuation method can be particularly useful if you have multiple comparable businesses. The more comparable businesses you have, the stronger your negotiating position may be.
2. Discounted Cash Flow
While the comparable method assesses extrinsic value, discounted cash flow (DCF) measures future intrinsic value (based on underlying perception of the value of your business). Since DCF looks toward future earnings rather than historical earnings, it can be particularly effective for early-stage businesses.
DCF sounds complex, but put simply, it’s a method that estimates how investment funds will affect your future cash flows while discounting the time value of money. For more information on this valuation method, see our article here.
3. Asset Valuation
Asset valuation places a value on all of your business’ assets and subtracts liabilities to arrive at a final valuation metric. An updated balance sheet can sum up your business’ assets and liabilities. Business assets are defined broadly as anything that has market value, and can include vehicles, machinery, equipment, copyrights, trademarks, patents, customer lists, and more. Your business’ leadership team and employees also have value, and investors can place a monetary value on each employee.
Liabilities include payroll, accounts payable, and business debt.
4. First Chicago Method
Specifically created for early-stage businesses, the First Chicago method provides three projections: the best case scenario, the worst case scenario and the expected scenario. Each scenario is assigned a probability (i.e., best case 25%, worst case 30% and expected 45%). Each scenario is assigned a monetary value, and the scenarios are averaged based on their probability to arrive at a final valuation metric.
Early-Stage Business Valuation: An Art, Not a Science
Valuation for early-stage businesses can sometimes be considered more of a negotiation art rather than a mathematical equation. For more information on company valuations, read our article on the four reasons a business owner would want to perform a company valuation.