The Most Effective Startup Valuation Method

An article we liked from Thought Leader Talia Goldberg:

Valuing early stage companies

When presenting a term sheet, I am often asked, “how did you come up with this valuation?”

I have heard VCs answer that question ambiguously by proclaiming that “valuing early stage startups is more art than science.” In my opinion, that is akin to admitting that you put your finger in the air and conjure up a valuation based on the way the wind is blowing.

At the series A stage, rarely does valuation reflect the fundamental worth of a business. This has been glaringly obvious as of late. Many startups that commanded nose-bleed valuations last year have quickly been rendered almost worthless. Even without these extreme examples, most series A stage companies have <$3m of revenue, no cash flow, and a short operating history. Using traditional financial valuation methods, most startups with that profile would be disappointed to learn they are worth at most single digit millions.

So what is your startup worth? Below are a few common valuation frameworks. I often use more than one method, but my favorite by far is the Scenario Analysis.

Common early stage valuation frameworks:

Ownership – focus on owning at least X% of the business for $Y
Discounted Cash Flow analysis – extremely unreliable with hyper growth startups given the unknowns of input variables
Multiple – e.g. 1x GMV, 25x ebitda, 15x revenue
Precedent transactions or comparables
**Scenario analysis**
Could this be the next Facebook? If so, pay anything
Finger in the air

A scenario analysis considers plausible scenarios that could take place and the likelihood of those outcomes coming to pass. It is a way of thinking in probabilities.

I learned this method at Bessemer, where nearly every investment memo includes a scenario analysis.

Scenario analyses are an acknowledgement that the future is uncertain. This is especially true for small startups. There is some chance that the founder gets hit by a bus or throws in the towel. There is some chance of a pandemic that drives tech adoption through the roof. There is some chance bitcoin hits $100k within...