Introduction and Purpose of Startup Valuation

Updated: Oct 11

Introduction


Startup Valuation is based on leading practices rather than set standards. Most early-stage startups’ valuation decisions take place during negotiations at their respective financing cycle including seed stage, early stage and expansion stage. However, they are still based on implicit valuation methodologies. Early-stage startup companies can be very different from one another in their respective startup cycle. Startups are typically defined as scalable business and revenue model, focusing on a fast growth rather than profits, often technology based. Another effective way to define them is through their financing story and cycle: Startups rely on multiple rounds of funding to grow, aiming at a high and short-term exit strategy or IPO strategy. In fact, the transaction defines the valuation methods to be used and depend on the startup story.



The practice of Standard Business Valuation for mature businesses reduces the risk and investment uncertainty. It is still a science under development as markets change and more market information is available. Since valuations are forward looking, the practice still involves a high level of judgment based on the past financial history, story and the future market conditions. Additionally, mathematical models used in traditional valuation methods were created and became more sophisticated with the availability of stock market data and other determinable market risks, which do not apply well to illiquid and non-transparent startup market.

Valuation Purposes


Valuation of early-stage startup and emerging technology companies includes valuation of Intangible Assets including IP, Patent and Trademark, often with the following purposes:


• Negotiating Technology licenses and Sales

• Internal resource allocation decisions

• Rewarding Inventors

• Obtaining venture capital investment

• Performing venture capital due-diligence

• Leveraging Intellectual Property and Technology as collateral for loans

• Valuation for acquisitions and mergers

• Tax issues

• Patent application decisions

• Possible damage claims in IP infringement suits

• Post-merger accounting

• Post- bankruptcy reporting

• Estate Planning

Although the primary purpose of standard business valuation is preparing a company for sale, the valuation can also be performed for a variety of purposes and reasons including Financial Transactions, Financial Reporting and Compliance, Litigation & Dispute Resolution and other internal purposes including Strategy Formulation, Business Planning and Capital Structure Repair.

The following are a few examples:

• Shareholder Disputes: sometimes a breakup of the company is in the shareholder’s best interests. This could also include transfers of shares from shareholders who are withdrawing.

• Estate and Gift: a valuation would need to be done prior to estate planning or a gifting of interests or after the death of an owner. This is also required by the IRS for Charitable donations.

• Divorce: when a divorce occurs, a division of assets and business interests is needed.

• Mergers, Acquisitions, and Sales: valuation is necessary to negotiate a merger, acquisition, or sale, so the interested parties can obtain the best fair market price.

• Buy-Sell Agreements: this typically involves a transfer of equity between partners or shareholders.

• Financing: have a business appraisal before obtaining a loan, so the banks can validate their investment.

• Purchase price allocation: this involves reporting the company’s assets and liabilities to identify tangible and intangible assets.


Stay tuned for the next article on key startup valuation methods.


By Dulal Das


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