Every business, either a Big Company or a Startup, has a price. The problem is that Startups are sometimes a bit more than just an idea. So how can we give value for something that is not tangible? According to Damodaran, an NYU finance professor who is widely respected for his work in valuation, the valuation process is the most screwed up.
Before discussing this topic, let’s differentiate the concepts of a Startup and a Large Companies. We will consider as a Large Company a legal entity, allowed by legislation, which allows a group of people, as shareholders, to apply to the government for an autonomous organization to be formed. This group can then focus on pursuing set goals, and empowered with legal rights, which are typically only reserved for individuals. In summary, a well-established enterprise. On the other hand, startups are not well established. Plus, you cannot define a Startup by its size or market. We will consider as Startup a company trying to solve any issue differently, or trying finding new solutions to old problems.
Usually, Startups need funds to grow. Finding self-funded startups is hard; most of them are supported by venture capitalists. Indeed, according to Crunch Base Insights research (2017) regarding the share of investor’s types within the global Unicorn Club, which is the list of private startups valued at more than $1 Billion. About 74% of the funds raised by those startups where from VCs (40%), Angel Investors (18%) and Corporate VC (16%). Moreover, this selected list was collectively valued at $663 Billion with a combined total funding of $126 Billion.
Every company, startup or a large corporation, needs to have a value. There are many ways to calculate the value of a Company. It takes into considerations revenues, assets, number of clients, market share, etc. All those tangibles figures help to calculate a value with higher certainty. Unfortunately, it doesn't work well for startups. Young companies are difficult to value for a number of reasons. A startup might not have customers or revenue, but it does not mean that its value is zero. Even those startups that are profitable have short histories, which make it harder to evaluate it. Also, it initially depends on owner savings and venture capital to keep developing the idea. The result is a huge amount of uncertainty, which leads to unrealistic valuations. Moreover, most young companies do not survive, and this must be considered in the valuation process.
For Early-Stage Startups, you can describe the valuation process as “an art rather than a science.” The first valuation follows a non-scientific rule, which says that the first investment round should support the founder for the next 18 to 24 months, period to validate the idea. And the value should varies between 5 to 30%. It shows how many shares the investor will have from your company. Later, during the scaling stage, the most common method to calculate the valuation is by comparing similar companies. Damodaran calls this the Relative Valuation, which uses multiples to compare similar companies. Usually, to well-established companies, the multiples are related to financial indices such as EBITDA. In startups, the multiples are different due to lack of historical financial data. For startups a multiple can be related to number of users, subscribers or downloads, for example. It is a less complex comparison. To make it simple, we can compare to real estate pricing. If your neighbor has a comparable house than yours, with similar size and similar facilities, it's easy to think that it is worth the same.
This explanation is a high level thought about how investors and founders decide to close a fund round. With these same ideals, we start to understand why startups from The Silicon Valley are naturally more valuable than the rest of the world. There you can find some of the most valuable startups in the world. And consequently, why most of the Brazilian startups are still far away that level. While according to CBI (2018) there are almost 300 unicorns in the world, nearly half of them in The Silicon Valley, Brazil has just one. After learning how to set a price for a startup, the big question is to understand why the location of the startup matters so much.