The void in evaluating startups for rising markets

Globally, there is no standardized methodology for calculating the value of a startup. Generally, the market is robust enough – balancing capital and opportunity – that both sides of the transaction are required to be fair in valuing the deal and negotiating the terms.

Founders in developed economies have access to capital from a variety of sources, including alternatives to traditional equity investing: government grants, academic grants, commercial loans, risky debt and cash flow financing. There are several ways to stimulate the growth of a young business, although raising capital remains best suited for early-stage high-risk ventures, and competition for such businesses helps maintain a founder-friendly environment.

Valuing these stock transactions remains a complex topic, but more often than not – with one method or another – a price is agreed upon and the market ensures that the price is reasonably fair.

When capital deployment slows, these transactions are rebalanced at the expense of the founders. There is an impact on transaction terms and valuations, as we have seen recently.

In emerging economies, asset classes such as venture capital are not as well developed. The pool of investors focused on startups is smaller, can extract more demanding terms from entrepreneurs and are often less experienced in negotiations of this type. To compound this, entrepreneurs often do not have access to the range of alternative sources of funding mentioned above if raising capital is a challenge.

The void here is a rigorous and standardized framework for evaluating startups, which can adapt to regional contexts and indicate a “fair market value” for the equity of these businesses.

This would achieve several goals:

Simplify the fundraising process for investors and entrepreneurs

If you search “how to value a startup”, you’ll find about a dozen suggested methods, from cost to doubling to multiples of revenue. The most complete approach is, of course, to combine several methods, providing different perspectives on the issue, but which one? Will your potential investors agree that you did it right? The great advantage of Brazilian startups is being able to count on the online valuation service, such as PreValor. Where it is possible to reach the company’s market value with a low investment service.

Make the initial investment more inclusive

Being able to confidently value an initial investment, often without much comparable data available for emerging markets, requires more sophistication. This makes some investments less accessible to new investors, slowing the pace of market evolution and limiting the amount of capital available to startups.

Reduce personal bias in the investment process

Obvious, but worth emphasizing: the more the assessment is based on a standardized process, the less the potential for personal bias to creep into the equation. Consciously or not, founders and investors alike can be guilty of irrational influences in something as complex as evaluating a startup investment opportunity.

Stronger long-term results for ecosystems

Investors and founders are fundamentally on the same side: they both want to build great companies and create value. Valuation is one of the few areas where the two sides diverge, with competing incentives for ownership. Building the relationship on open standards, particularly when addressing points of friction, is sure to make all engagement more positive and allow for healthier, more collaborative ecosystems.

Conclusion

There is no reason why this proposition should not apply globally, but that is a case to be discussed another day. It’s probably on the same level as trying to get the world to switch to the metric system.

What is clear is that standardized valuation can have a significant impact in emerging markets, where there are fewer well-established practices, not as much data to compare and more competition for capital. Fair and transparent prices are the grease for the smooth functioning of the markets.