A Complete Guide to startup Valuation Methods
Valuing a business is essential for various purposes—selling, buying, securing funding, taxation, or restructuring. The method used depends on the company’s stage, from startup to decline. In this guide, we'll break down each method in detail and explain when and why it's used.
1. Business Lifecycle and Its Impact on Valuation
Businesses don’t remain static—they evolve over time. Here’s how a company’s lifecycle affects its valuation:
A. Startup Stage (Early Years)
The business is new, often operating at a loss.
Revenue is minimal or non-existent.
Investors focus on potential, not profits.
B. Young Growth Stage
Revenue begins increasing as the company gains traction.
The business might still be unprofitable but shows promise.
Investors assess growth potential over current financials.
C. High Growth Stage
Rapid revenue and customer base expansion.
Profitability may still be uncertain, but growth is strong.
Valuation focuses on projected earnings and sales multiples.
D. Mature Growth Stage
Steady and predictable revenue growth.
The company is profitable with strong financial records.
Investors value the business based on earnings and cash flow.
E. Mature Stability Stage
Growth slows, and the business reaches market saturation.
The company generates consistent profits but limited expansion.
Valuation is based on long-term earnings and stability.
F. Decline Stage
Revenue and profits start decreasing due to market changes or competition.
Business restructuring or liquidation may be needed.
Valuation is based on tangible assets rather than earnings.
2. Business Valuation Methods Explained
Each stage requires a different valuation approach. Below, we discuss methods suited for selling, buying, securing funding, taxation, and restructuring.
A. Selling a Business
When selling a business, the goal is to determine a fair price that reflects its true worth.
1. Startup Stage: Scorecard Method (Berkus Method)
Since startups have little or no revenue, investors value them based on factors like:
Strength of the founding team
Market opportunity
Competitive advantage
Product development progress
Example: A new AI-based legal automation startup has no revenue but a strong founding team. Investors use the Berkus method to estimate its worth.
2. Young & High Growth Stages: EV/Sales (Enterprise Value/Sales)
Used when a company has revenue growth but isn’t yet profitable.
Investors compare the company’s total value (Enterprise Value) to its annual sales.
Example: A fast-growing e-commerce platform with high sales but no profits is valued based on its revenue multiple.
3. Mature Growth & Stable Stages: EV/EBITDA (Enterprise Value/Earnings Before Interest, Taxes, Depreciation, and Amortization)
When a business is profitable, valuation is based on its operational efficiency.
EBITDA helps assess how well the company generates cash flow.
Example: A hotel chain with steady income is valued using EV/EBITDA.
4. Decline Stage: Price-to-Book Ratio (Net Book Value)
When a company is declining, valuation shifts to tangible assets like real estate, machinery, or inventory.
Example: A failing retail store chain is valued based on its property and inventory worth rather than revenue.
B. Buying a Business
Buyers need to evaluate a company’s worth before purchasing it.
1. Startup Stage: Berkus Method (Scorecard)
Similar to selling a startup, buyers assess its potential rather than financials.
Example: An angel investor looking to buy into a health-tech startup evaluates its market potential instead of revenue.
2. Young & High Growth Stages: DCF with Sensitivity Analysis (EV/Sales)
Discounted Cash Flow (DCF) estimates future earnings and adjusts for risk.
Sensitivity analysis tests different growth scenarios to see how valuation changes.
Example: A fintech startup expecting strong future sales is valued using DCF projections.
3. Mature Growth & Stable Stages: DCF (EV/EBITDA)
Buyers analyze a company's earnings and discount future cash flow to determine its present value.
Example: A transportation company with consistent profits is valued based on EBITDA multiples.
4. Decline Stage: Liquidation Method (Price-to-Book)
If a company is shutting down, its valuation is based on selling assets.
Example: A struggling newspaper company is valued based on its physical assets like printing presses and office buildings.
C. Securing Funding (Investment Valuation)
Investors use valuation to decide how much to invest in a business.
1. Startup Stage: Replacement Cost Method (EV/TAM)
This method estimates the cost of recreating the business from scratch.
Example: A ride-sharing startup is valued based on the cost of developing its app, hiring drivers, and building brand awareness.
2. Young & High Growth Stages: DCF with Projected EBITDA Multiple
Investors project EBITDA and adjust for future risks.
Example: A SaaS (Software as a Service) company with rapid growth but uncertain profitability is valued using projected earnings.
3. Mature Growth & Stable Stages: DCF (P/E - Price-to-Earnings Ratio)
Measures how much investors are willing to pay per unit of earnings.
Example: A pharmaceutical company with stable profits is valued based on its P/E ratio.
4. Decline Stage: DCF (Net Book Value)
Investors focus on asset values rather than profitability.
Example: A textile factory nearing closure is valued based on its machinery and real estate.
D. Taxation Valuation
Businesses need valuations for tax assessments.
1. Startup Stage: Net Book Value (Replacement Cost Method)
Tax authorities assess a business’s value based on its physical assets.
2. Young & High Growth Stages: DCF with Net Book Value
Future earnings projections are considered for tax calculations.
3. Mature Growth & Stable Stages: DCF (P/E)
Used for profitable companies with stable earnings.
4. Decline Stage: Liquidation Method (Net Book Value)
If the company is closing, taxes are based on asset liquidation.
E. Business Restructuring (Mergers, Acquisitions, Bankruptcy)
Companies undergoing major changes need valuation for strategic decisions.
1. Startup Stage: Replacement Cost Method (Net Book Value)
If a startup is restructuring, investors assess the cost of rebuilding the business.
2. Young & High Growth Stages: DCF with Projected EBITDA
If a business is merging, future earnings determine its worth.
3. Mature Growth & Stable Stages: DCF (EV/EBITDA)
Helps companies decide on restructuring strategies like downsizing or expansion.
4. Decline Stage: Liquidation Method (Net Book Value)
If a company is closing, valuation focuses on selling off assets.
Final Thoughts
Different valuation methods apply at different stages:
Startups: Value is based on potential, not profits.
Growing Companies: Projections and sales multiples are key.
Mature Companies: Profits and earnings determine value.
Declining Businesses: Asset valuation becomes more important.