A Manifesto for Startup Valuation
Home > Startup Valuation Book and In-Depth Guide
Understanding startup valuation is critical for startup investors and founders. This book and in-depth guide will teach you how to Evaluate a Startup, giving you the knowledge and skills to confidently move through evaluating and negotiating your deal.
This isn't just another book — it's a manifesto for startup founders and venture investors which equips them with the wisdom to flourish in turbulent innovation terrains and offers a blueprint to spearhead venture risks necessary to business resilience.
Anthony J. Tether, former Director of the U.S. Defense Advanced Research Projects Agency (DARPA)
What if you could prove a startup's value before having big revenue?
A new methodology is transforming how investors evaluate early-stage startups, focusing on strategic validation rather than traditional cash-flow metrics. While you're sticking to outdated and rigid techniques, startups with weaker products but smarter valuation strategies are winning this venture rush.
Startup Valuation Guide
CONTENT
1. What is a startup?
A startup is a company specifically designed to achieve rapid growth. In their earliest stages, startups usually operate without revenue (pre-revenue stage), without users (pre-user stage), or even without having a working product (idea stage). Read more
2. What is Startup Valuation?
Startup valuation is the process of determining the economic worth of a business usually necessary to understand when fundraising or investing into startups. There are several reasons why valuing a startup is very different from valuing an existing business, especially for new startups, or putting simply early-stage startups. Read more
3. Why is Startup Valuation Important?
Reasonable valuation helps startup founders attract venture capitalists faster as it provides a basis for negotiating how much equity to give up in exchange for money on the one hand, and helps venture capitalists decide if the possible return is worth the risk when they are making investment choices. Read more
4. Primary Startup Valuation Methods
There is a number of traditional and modern company valuation methods that can be used to determine valuation of an early-stage startup, scaleup, or growthup, each with its strengths and limitations. Read more
5. What Does Effect Startup Valuation?
Read about how a number of factors effect your valuation such as size of the market and growth potential, product or service differentiation, team knowledge and experience, and more. Read more
6. Practical Advice for Founders
Know how to prepare for good valuation properly, negotiate your valuation with confidence, and understand major investment terms such as pre-money valuation vs. post-money valuation, liquidation preferences, anti-dilution provisions, and more. Read more
7. Investor Perspective
Investors evaluate startups through multiple lenses, prioritizing strong teams with realistic financial models, clear market value, scalability potential, sizable market opportunities, and more. Learn about this and what are key investor metrics to assess business health and potential returns. Know how to prepare for good valuation and negotiate your valuation with confidence. Read more
8. Must Have Reading and Resources
Smart founders know that mastering startup valuation isn't just about numbers. It is about learning from those who have already succeeded, with essential reads like "Venture Deals" and real-world data from CB Insights forming your knowledge foundation. Stay ahead like top entrepreneurs by tuning into insider conversations with Reid Hoffman and Jason Calacanis, who reveal the unwritten rules of startup success. Read more
9. IMPORTANT Considerations
Good numbers help sell your startup's story, but investors really want to see that real people love using your product, your team works well together, and you have built solid relationships in your industry. The best investors don't just stare at spreadsheets – they are looking for startups that could change how things work in meaningful ways. Great founders understand this balance... Read more
1. What is A Startup?
A startup is a company specifically designed to achieve rapid growth (Dealroom, 2024). These innovative ventures are typically backed by venture capital investors, aka angels if individuals, who see high potential for returns.
In their earliest stages, startups usually operate● without revenue (pre-revenue stage), ● without users (pre-user stage), or ● even without having a working product (idea stage).
This early-stage phase is particularly challenging as startups focus on product development, market validation, and on building their initial user base in order to prove their business model and establish product-market fit. Strictly speaking, startups that generate less than $50,000 in monthly recurring revenue (MRR) are the early-stage ones still validating their business model and working toward scaling and sustainable growth.
When startups succeed with their growth strategies, they evolve through the next stages: first into scaleups with more than $50,000 MRR, then into growthups exceeding $1,000,000 MRR, and ultimately emerging as established corporations. Some startups reach extraordinary valuations exceeding $1 billion, earning the "unicorn" status in the startup ecosystem, or even $10 billion valuation earning the “decacorn” status.
2. What is Startup Valuation?
Startup valuation is the process of determining the economic worth of a young company. Valuing a startup is very important. It needs a special method, especially for new startups.
A Simple Explanation for a Broad Audience
At its core, startup value is figuring out how much money a company in its early stages could make in the future. You can't tell how big the tree will get from the seed. The process looks at things like the size of the market, the strength of the team, how special the product is, and how the company can grow. Early investors in Airbnb, for instance, apparently thought about more than just the small gains the business made at first. Always think about the future when you're judging a company.
Why Startup Valuation Different from Valuing an Existing Businesses
There are several reasons why valuing a startup is very different from valuing an existing business.● Companies that are new don't always make money, so normal ways of valuing them that are based on past success don't work for them. This is why investors and founders need to put their money where they think it will do the most good.● Growth potential: a startup's real value is not in how it is now, but in what it could become in the future.● Uncertainty and risk: since startups operate in uncharted territories, this makes their future success harder to predict. This is why venture capitalists often invest in several startups, understanding that many of them may fail, but one big success can offset several losses.● Intangible assets, such as a startup's intellectual property like copyrights and the collective expertise of the team, become a significant portion of a startup’s worth.● Startups tend to stick to their strategies, better say rigid, which makes it less adaptive and less confident in how they will do in the future.
Related Articles
● The Hypothesis Testing Method for Startup Valuation and Management● The Method of Real Options to Evaluate Innovative Startups ● Real Options Approach to Evaluate Strategic Flexibility of Startups● Financial Tools for Managing Startup Projects● Real Options for Assessing Financing Strategy and Startup Valuation● Valuation of a Source of Startup Funding Using Real Options Approach
3. Why is Startup Valuation Important?
For Founders
● Raising investments: Reasonable valuation helps you attract venture capitalists faster as it provides a basis for negotiating how much equity to give up in exchange for money.● Team motivation: On early-stages, equity is a great way to get and keep good talent. When early employees understand the potential value of their equity stakes, it can drive them to work harder for the startup’s success. This is very important when you are short on cash and can't pay high prices.● Fair pricing: A good price keeps founders from giving away too much of their business too soon. If a founder undervalues their business and gives away 50% for a small investment, for example, they might not be able to get more investments in future or might even lose control of their business.
For Investors
● Valuation helps investors decide if the possible return is worth the risk when they are making investment choices. Venture capitalists, for example, want at least a 10-fold return on their investments to make up for the high risk of investing in startups.● Getting a correct valuation lowers the risk of paying too much for a piece of the company. This is very important because paying too much can cut returns by a lot, even if the company succeeds.● Venture capitalists and angel investors need to know how much startups are worth in order to handle their investment portfolios well. They need to mix investments with a lot of risk and profit with ones that are safer.
4. Primary Startup Valuation Methods
There is a number of traditional and modern company valuation methods that can be used to determine valuation of a startup, each with its strengths and limitations. Being crucial tools for both founders and investors, these startup valuation methods, however, can't compare with the Hypothesis Testing Method suggested here.
DCF Method: for startups with predictable revenue
Discounted Cash Flow (DCF) Method is the most common traditional business valuation approach that is based on projecting future cash flows and discounting them back to present value. It uses a conventional linear concept of Time Value of Money converted into a discount rate as a demeanor of risks related to the uncertain future. It's particularly useful for scaleups and growthups with more predictable revenue streams so that their risks are based on the general factors accounted into a discount rate.
Formula: DCF = CF1 / (1+r)^1 + CF2 / (1+r)^2 + ... + CFn / (1+r)^n , where: CF = Cash Flow, r = Discount Rate, n = Number of Years.
In this case, a startup might be worth $15–20 million if it expects its free cash flow to be $1 million in the first year and to grow at 20% per year for 5 years, with a discount rate of 15% and a terminal multiple of 10x.
DCF Method is a basement for many other derivative approaches such as Income-based Valuation that is based on the income the business is expected to generate over time. It's similar to the DCF method but may use different techniques to project future income.
Berkus Method: For early-stage startups
The Berkus Method, developed by angel investor Dave Berkus, is widely used for evaluating early stage startups as it is very simple and straightforward approach. Instead of requiring bulky financial modelling, it assigns a monetary value to five startup’s success factors:
1. Sound idea (basic value): Up to $1 million2. Prototype (reduces technology risk): Add up to $1 million3. Quality management team (reduces execution risk): Add up to $1 million4. Strategic relationships (reduces market risk): Add up to $1 million5. Product rollout or sales (reduces production risk): Add up to $1 million
Under this method, a company with a good idea, a working prototype, and a strong team but no sales yet might be worth $3 million.
VC Method: For early-stage startups with high growth potential
Venture Capital (VC) Method is popular among venture capitalists evaluating startups with high growth potential. It keeps a narrow focus on the expected return at exit applying an IRR (Internal Rate of Return) or a minimum required/expected return logic to a required investments and vice versa.
Formula: Post-money Valuation = (Exit Value) / (Expected ROI), Pre-money valuation = Post-money Valuation - Investment Amount.
As an example, if a venture capitalist thinks that a company will be worth $100 million when it goes public in 5 years and wants a 10x return on their $5 million investment, then the post-money valuation is $100M / 10 = $10M and the pre-money valuation is $10M - $5M = $5M.
Risk Factor Summation Method: For early-stage startups
This method is another good way to value early-stage startups. Instead of just using financial metrics, it measures a number of qualitative risk factors that could affect the success of the company. The process begins with a base value, typically derived from Berkus or VC Methods. The process begins with a base value, typically derived from Berkus or VC Methods.
Common risk categories may include: management risk, stage of business, legislation/political risk, manufacturing risk, sales and marketing risk, funding/capital raising risk, competition risk, technology risk, litigation risk, international risk, reputation risk, potential lucrative exit.
A standard scale, usually running from -2 to +2, is used to rate each risk factor. Lower scores mean more risk, while higher scores mean opportunities or factors that lower risk. The base value is then changed based on the total effect of these ratings. This gives a more complete valuation that looks at both the quantitative and qualitative parts of the business.
Multiple Method: For startups with predictable revenue
In this method, aka company comparison and peer analysis, the startup's financial success is predicted up to a certain point in the future (usually the exit), and a valuation multiple based on similar companies is used, such as price to earnings, price to EBITDA, price to sales, and so on.
When applying the Multiple Approach, follow these simple steps:● Forecast future revenues, expenses, and earnings.● Apply an appropriate multiple based on industry standards such as price to earnings, price to EBITDA, price to sales, and so on.● Discount the future value back to present using DCF Method explained above.
Multiple Approach can be particularly useful for startups with predictable revenue and in industries with established valuation multiples.
Cost-to-Duplicate Method: For startups with tangible assets
Based on how much it would cost to build the same startup from scratch, this can include rebuilding real assets, creating intellectual property, putting together a team, getting a foothold in the market, and so on. For startups with valuable physical assets or unique technology, the Cost-to-Duplicate Method is especially helpful because it gives a clear starting point value based on measurable development costs and infrastructure investments.
This method works best when: ● Substantial IP/patents exist, making reproduction costs quantifiable● Physical assets or specialized equipment form a major part of operations● Complex technical development would require significant time/resources to replicate● Market entry barriers are tied to specific infrastructure or capabilities
For example, a biotech startup with custom lab equipment and patented processes can be valued more accurately this way than using purely market-based methods. However, this method may undervalue companies where the main assets are intangible (like brand value or network effects). Cost-to-Duplicate Method is an asset-based type of valuation that is a fundamental approach to determining a startup's worth by assessing the total value of its possessions and resources.
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5. What Does Effect Startup Valuation?
Size of the market and growth potential
When you evaluate market potential, you need to pay close attention to three factors. First, the total addressable market (TAM), which is the total amount of money the company could make if it could reach all of its target customers. Second, the market's growth trajectory, since markets that are growing quickly give new startups more room to grow, And third, the realistic market share the startup could get given its competitive advantages and ability to carry out its plans. These three things set a limit on what the company could be worth.
Team knowledge and experience
The people behind a startup can make it worth much more to investors. When founders have already built and sold successful companies, investors see less risk and often value the company higher. When you have someone in your team who really knows the industry inside and out is crucial. For founders, it means they are less likely to fail. On top, a big name on board as an advisor or executive team member can open you some doors and add credibility.
Product or service differentiation
A startup's value jumps significantly when it has something truly special that sets it apart from the crowd. Investors look for solutions that don't just match what's already out there, but solve problems in a clearly better way - like how Uber made getting a ride dramatically easier than hailing a taxi. But having a great idea isn't enough; the startup needs something that makes it hard for others to copy their success, whether that's special technology they've developed, a patent that protects their invention, or the kind of network effect that makes Facebook valuable because everyone's already using it.
Technology and intellectual property
The long-term value of a startup is built on its technology and intellectual property. When you get patents and trademarks, they protect your new ideas and give investors confidence in the marketability. Unique technology that is hard to copy adds massive value, and research and development competencies that have been proven to work add extra confidence in your creativity.
Traction and customer acquisition
How quickly and easily you can attract, acquire, engage, and keep customers has a big impact on your valuation. Fast user growth demonstrates a product-market-fit (market acceptance) and further scaling potential. Even in pre-revenue stages, strong customer engagement and retention must serve as a proof of product-market-fit. When you put it together with consistent revenue growth dynamics, these can tell you an appealing story of long-term business growth.
Investor sentiment and market conditions
The overall economic situation and market trends play a significant role in shaping startup valuation beyond business metrics. Apparently, a growing economic environment drives higher valuation as investors get more appetite for risk, while specific industry momentum, not to mention hypes, open good funding opportunities. Valuation of competitors, for example through recent exits or funding rounds, establish valuation benchmarks.
6. Practical Advice for Founders
Prepare for good valuation
1. Keep your financial model and related documents in order, up-to-date and accurate.2. Design a thoughtful business model clearly articulating how you will make money and become profitable.3. Measure your assumptions and projections with specific product, marketing, technological, business and more metrics and performance indicators showcasing that you understand every single piece of your business.4. Be realistic about your projections and expectations, use reliable data sources, realistic assumptions about growth, available resources and their productivity,5. Keep your legal documents and other business information ready at one place (data room) for immediate investor due dilligence.6. Validate your hypotheses and assumptions as early as possible to provide more convincing evidence to investors and early adopters.
Negotiate your valuation confidently
● Devise your data backed valuation strategy. Determine the minimum, desired, and maximum valuation and terms you are willing to accept before negotiations begin. ● Use venture capital industry benchmarks for your closest available region. Refer to verified and reliable data sources only. ● Choose and reason your primary valuation method but have evaluations using the others to oppose.● Know about major types of investment terms and concepts like liquidation preferences, anti-dilution provisions, board seats, SAFE, ASA, SHA, SEIS-EIS, and more.● Don’t accept the first offer immediately, take a few days to think it over if the valuation is below of your target. Try to argument your valuation better or wait for other offers. ● Engage with multiple investors as much as possible to create competitive tension.● Keep your round closure time for in-person conversations, don’t state it in your pitch deck. This must give you agility and let you avoid inconvenient questions about how long you have already raising.
Know about major investment terms
● Pre-money valuation vs. post-money valuation: Pre-money is the company's value before investment, while post-money is the value after investment.● Liquidation preferences: This determines the order and amount investors receive in a liquidation event.● Anti-dilution provisions: These protect investors from dilution in future down rounds.● Vesting schedules: These apply to founder and employee equity, ensuring long-term commitment.● Option pools: These are reserved equity for future employees, often set up before a funding round.
7. Investor Perspective
What investors look for in a startup valuation
1. Strong team reflected in financial model: Experienced founders, executives, and key personnel with relevant skills can’t cost chicken feed hardly covering living costs. Be thoughtful when designing you financial model.2. Confirmed value for customers: Clear differentiation from competitors must be reflected in the ambitious financial and growth projections. Obviously, it is very good to have some validation of product-market-fit based on traction or at least on customer interviews and surveys.3. Scalability potential: Your ability to grow rapidly shouldn't come at the expense of burning excessive capital. Your financial model needs to demonstrate how increased revenue leads to improved margins through efficient operations, using realistic market penetration assumptions.4. Market opportunity: The size of your addressable market must justify ambitious growth projections in your financial model. While targeting a large market is important, your growth strategy should clearly demonstrate how you'll capture a realistic share through specific channels and resources. The market's growth rate should support your expansion plans.5. Exit potential: Outline clear and achievable paths to investor liquidity in your financial model, whether through strategic acquisition or public offering. Support your projected valuation at exit by comparable transactions in your industry. Don't just state that tech giants will acquire you, demonstrate how your business development strategy aligns with potential acquirers' interests and typical deal parameters in your industry.
Key metrics and financial indicators used by investors
● Customer Acquisition Cost (CAC): The cost of acquiring a new customer.● Lifetime Value (LTV): The predicted net profit from the entire future relationship with a customer.● Burn rate: The rate at which a company is losing money.● Monthly Recurring Revenue (MRR): Predictable revenue generated each month.● Churn rate: The rate at which customers stop doing business with the company.● Gross Margin: Revenue minus cost of goods sold, divided by revenue.● Year-over-Year (YoY) growth: Annual growth rate, crucial for demonstrating traction.
How investors make investment decisions
● Initial screening: Quick assessment based on pitch deck and initial meetings.● Due diligence: In-depth examination of the business, financials, and market.● Financial modeling: Projecting potential returns under various scenarios.● Risk assessment: Evaluating potential downsides and mitigation strategies.● Investment committee review: Final decision-making process, often involving multiple stakeholders.● Term sheet negotiation: Discussion and agreement on key investment terms.● Closing the deal: Finalizing legal documents and transferring funds.
8. Must Have Reading and Resources
To deepen your understanding of startup valuation methods, consider exploring these resources:
Books
1. "Venture Deals" by Brad Feld and Jason Mendelson.2. "The Startup Owner's Manual" by Steve Blank.3. "Angel Investing" by David S. Rose.4. “Fundamentals of Entrepreneurial Finance” by Marco Da Rin, Thomas Hellmann.5. “When Businesses Test Hypotheses: A Four-Step Approach To Risk Management For Innovative Startups.” by Dmytro Shestakov.6. Find more must read books for founders here.
Online courses
● Y Combinator's Startup School.● Kauffman FastTrac.
Websites and newsletters
● The U.S. National Venture Capital Association (NVCA).● CB Insights for market research and startup data.● Dealroom to access startup and venture capital data, funding rounds, valuations, and industry analysis.● PitchBook for detailed information on private market investments and exits.● Crunchbase for startup funding data and company information tracking.● TechCrunch and VentureBeat for latest startup news and funding announcements.
Podcasts
1. "This Week in Startups" with Jason Calacanis for weekly deep dives into startup trends, funding news, and founder stories.2. "Masters of Scale" with Reid Hoffman exploring how companies grow from zero to growth through founder interviews and narrative storytelling.3. "The Twenty Minute VC" with Harry Stebbings for insights from top VCs and founders.4. "Startup Stories by Mixergy" with Andrew Warner featuring in-depth founder interviews.
9. Important Considerations
How to value a startup company with no revenue
There are particular difficulties in valuing a startup that has no revenue, described here. Here is a few additional tips:● Focus on the potential market size and the startup's ability to capture it.● Pay attention to the size of the prospective market and the startup's capacity to seize it.● Examine the team's experience and track record.● Evaluate the technology's or intellectual property's strength and distinctiveness. Give extra credits if there are patents and copyrights. ● Consider the cost of building the product or technology.● Look at comparable companies at a similar stage.● Research and compare benchmark companies and industry peers.
Startup evaluation and management
1. Startup evaluation extends beyond merely looking at financial indicators. Additionally, it is essential to take into consideration:2. Validation of product-market-fit: Happens when you have early customers or, at least, users.3. Validation of business model. I assume that a startup validated its busess model when its revenues cover costs, aka break-even point (BEP) in finance.4. Satisfaction and reviews from customers.5. Culture and the dynamics of the team.6. Strategic partnerships, alliances, grants, reputable investments, etc.
Startup valuation is both an art and a science. While these methods provide a framework, the true value of a startup lies in its potential to disrupt markets and create lasting impact. As a founder, your job is not just to build a great product, but to effectively communicate your vision and the value of your company to potential investors.
As an investor, I am always looking beyond the numbers to understand the unique potential of each startup is key to finding those rare, transformative opportunities. By mastering the principles of startup valuation, you will be better equipped to navigate the complex world of entrepreneurship and technologies.