How to evaluate your startup today: look to tomorrow￼
Ella Fitzgerald said, “It’s not where you came from, it’s where you’re going that counts.”
The American singer’s advice, it seems, is appropriate not only for jazz singers, but also for companies considering their valuations in the current economic climate.
See how startups should assess their valuation in today’s market based on these timely words.
Keep the past in the past
It’s natural to base your company’s valuation on multiple assumptions your investors made in your previous funding round. At that time, perhaps together, you agreed to expect a multiple of 2x to 3x in the next round. But what is this really based on? How do assumptions made a year or two ago carry weight in today’s market – especially the current downturn we’re experiencing?
Looking back to today’s assessment is a flawed formula. Instead, looking ahead adjusts your focus to where it should be: where the business is going and how to get there.
Assuming your goal is to eventually go public, sell to a public company, or even an M&A with a large private company, a great place to start is with the information you have. You can look at today’s public markets and, more specifically, how publicly traded companies in your vertical are doing right now.
How to value your company looking forward
Simply put, use a multiple that aligns with your industry. The problem for many startups, especially earlier ones, is that these multiples can put them in an unrealistic situation. When a startup raises its seed capital, it typically has no sales, no customers, and therefore no multiples. Over the lifecycle of a successful startup, it will grow faster and “grow” at its projected valuation.
A deeptech startup may only acquire its first customer after Series A, while a product-led growth software startup may be building its community before worrying about revenue. To compensate for this when calculating the valuation, you need to look forward enough and then work backwards.
From the future to the present
Let’s imagine that a startup is calculating its valuation. It starts by looking five years ahead and sketching what this company might look like using a suitable multiple.
Suppose you then hit $100 million in annual recurring revenue; looking at similar multiples, it should be valued at 20x or $2 billion (clearly there are many other factors and this is a simplified version).
Now that we’re five years ahead, let’s go back to today: let’s suppose that 2.5 years before that, an investor could invest $800 million, which brings us to today, when someone can invest at a valuation of $300 millions.
The above assessment “milestones” may be reflected differently based on startup stages, industries, geographies, and more, but the power of this model is twofold:
- Reinforce the model by checking with investors at a later stage. Find out if your assumptions for future funding, in addition to maintaining certain milestones, are in line with expectations.
- Especially relevant today: If there is a change in the market, it is easy to account for. Note the $2 billion assumption change (based on your public market multiples) and adjust the rest of your model.
You could argue that it deserves more, but the scope is pretty clear.