Evaluation and comparison of different methodologies employed for valuation of startups

Abstract

A startup is a company in its early stage of operations and is usually characterized by high growth potential, high costs and low or limited revenues. Startups usually address product or service problems that are typically not solved by existing firms in the industry and rely on angel investors or venture capitalists for their funding. Unlike existing firms in the market which have stable growth rates and predictable earnings and cash flows, startups are highly volatile with cashflows often in the negative and a high risk of bankruptcy. Given the uncertainties involved, valuing a startup through methods commonly used for valuation of mature firms does not yield good results and often results only in ballpark estimates. That said, a few methods have withstood the test of time and are used regularly to value startups in various stages of their growth In this report, we examine 4 different startup valuation methods – the cost to duplicate method based on the market value of assets, the multiples method using revenue multiples, the discounted cash flow method, and the First Chicago method. We aim to identify which of these methods yields the closest estimates of a startup’s post-money valuation.