How Do You Value a Startup?

What is a startup and how is it valued?

A startup is typically a venture that aims to bring a new and innovative service, product or process into the marketplace. The founder is generally the entrepreneur who runs with the idea. The founder often starts small and looks for angel / venture funding. There are a number of avenues that can be utilized to secure funding and get momentum.

The founder is often a passionate new entrepreneur from a venerable B-school who does not want to limit the potential of the idea, a group of young and fired up management and technology majors can be instrumental in initiating a dynamic platform. The risk here is not huge as the founders still have the option to go back to the drawing board if the venture faces problems.

In the other scenario the founders could be experienced veterans of the technology or corporate world who have given up humongous salaries to set up their dream project. This is more fraught with risks as the capital and labor in the initial stages is often the life savings of the entrepreneur. One very successful example is that of the Chumbak duo who flagged off the venture in March 2010 with a mere 40 lakhs. The souvenir brand has now grown over 300% year on year in the last 5 years. There have been 2 successful rounds of funding and there is a lookout for more.

Investment Thesis and Its Matrices

Once the startup takes shape and the methodology and investment story is clear it is time to evaluate and look for funding to take the venture to the next level. All ideas and methodologies are not capable of securing adequate funding. The basic matrices that are the cornerstone of the investor thesis are common to most startups and should be presented with crystal clear reference.

Revenue and user growth are the common markers that flag the quest for funding. The basic nature of the company’s business activity and prospects are critical. But, in the long run it is not only the metrics that touch a chord with the limbic system that touch a nerve. The company’s vision and mission also plays an important role. The venture funding biggies are also on the lookout for companies that can

● Explain the investment thesis of the venture in a responsible and in depth manner
● Present the evidence that matches and explains the thesis in real time
● Evaluate the requirements to achieve the long term vision of the company and provide a road map for the same

Five Major Matrices that Secure the Attention of Venture Funds

The broad groups that can be defined as matrices for funding are sales, financials, user, acquisition and marketing. Statistics are important but relevant weightage is duly given to all matrices depending on the type of startup and the industry relevance. The thought process of the VC matters too!

Financial Metrics

Finances are very crucial for a startup, and some startups are funded by venture capitalists just because of a strong statement of positive cash flows.

The Monthly Revenue Growth is an important statistic to present correctly. It can be reached by taking the current monthly revenue, then subtracting the last month’s revenue and dividing by the same number. This is a methodology often favored by the founders as it can be arrived at without a magnitude of scale. Generally a guideline of 40% growth is deemed attractive by the investor. Then the subject is open to conjecture how an infusion of capital will drive marketing and sales.

The Revenue Run Rate measures the revenues that are recognized in the last viable month and multiplied by 12. VC’s are interested in the current revenue run rate and the projected annual revenue rate. These are viable numbers as they take magnitude into consideration. The plan is drawn for the next couple of years as the VC is very aware that the venture will require additional funding in due course of time. The growth trajectory should be well defined.

Gross Margins are calculated on the premise that total revenue minus cost of sold goods, divided by the revenue. Net margin also accounts for the total expenses of the business also. This is an important metric as it signifies the ability of the startup to utilize the venture capital in a productive manner. It is imperative that there is a plan to articulate a workable strategy to minimize margin compression due to competition and escalating costs.

Burn Rate and Runway signifies the foreseen operating loss that is projected on a monthly basis. This is the metric that gives the VC the sense of how long the cash will last. These numbers are the indicators of the efficiency of a business and the timeline for the next round of fundraising. The VC would evaluate how the expenses would scale with the infusion of venture capital.

User Metrics

Users or end consumers are the lifeblood of a startup, and the VCs analyze the data of the users very minutely. Popular user metrics include Daily Active Users (DAUs) as well as the Monthly Active Users (MAUs). K-Value is a measure of the magnitude of the user growth numbers in an organic manner. The virality of the product or service is measured by this metric. This is often the most important measure that the VC will examine.

Proportion of traffic generated from mobile visits generates a ratio against the total traffic, which is also of some importance. The figures that demonstrate mobile engagement are often indicative of success or failure.

Cohort Analysis is an important metric by which the VC can see the user engagement. Cohort analysis tables give a perspective on user engagement. It also factors in data for seasonal analysis. All the factors together present a larger whole.

Marketing Metrics and User Acquisition

Cost of customer acquisition and payback is the basic revenue model for all subscription based companies. The cost of user acquisition in the form of Search engine marketing, public relations and content marketing and so much more is divided by the new users in a pre-ordinated time frame. This is indicative of the cost of acquiring end customers. Compiled with the number of organic new users, it signifies the fund needed to drive growth. This is the metric that defines revenue generation.

Sales Metrics

Revenue is built by sales channels. There is a magic number that signifies the ratio that is achieved that shows the VC an estimate of Return on Investment on every dollar spent. If the ratio is over one then the scope of scaling up is very high, and the magic number below one means that there is a lack of efficiency in the achievement of scale.

The basket size or the order velocity signifies the average sales price. The time taken by the customer to make a second/repeat purchase denotes the order velocity. This is often the most important metric for E-commerce. The Average Sales cycle is the average of the time taken by the customer to make the first purchase. A cycle of less than one year is considered good.

The Long Term Value (LTV) is the value of the customer generated over a lifetime. This is a very significant metric, although measuring it may not be very easy. These numbers are very important for long term sustainability.

Market Metrics

Startups compete for a limited resource available from customers. Measuring the size of a market and the composition of the same is the most significant metric analysis and determines the potential value for a company. The Total Addressable Market denotes the amount of money that is spent in the defined space of the startup. This allows the founder of the startup to quantify the startups market value and scope.

All said and done, the discerning investors have their own approach for each unique startup. The above mentioned guidelines are very general in nature and more definite and specific information of each industry should be kept in mind. This is the best benchmark to judge the value of the startup.

Ishan Singh
MD & CEO, RevStart