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How to Value a Startup Business
HOW TO
VALUE A
STARTUP
BUSINESS
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Introduction
The business world is filled with prime examples of startup firms who famously went
from small teams set up in a garage or moms basement to burgeoning companies
now employing the worlds top thinkers and making waves in the economy. While
these top-rated companies may have started from next-to-nothing, they made a very
important move in their growth they managed to properly value their companies
from the beginning, using that foundation as the basis for exponential gains. This
whitepaper seeks to present the process of providing a proper valuation for a startup
firm, reinforcing the need for accuracy with famous upstarts as case studies.
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How to Value a Startup Business
1 Market Value. Investopedia, n.d. Web. 11 July 2014.
2 Robehmed, Natalie. What Is A Startup? Forbes. Forbes Magazine, 16 Dec. 2013. Web.
What is market value, anyway?
Simply put, market value is the price an asset would fetch if sold in the marketplace.
In terms of business and economics, market value most often refers to the market
capitalization of a publicly traded company. The quick-and-dirty way of determining
that valuation comes from multiplying the number of its outstanding shares by the
current share price.
1
Market valuation is an important concept to understand and critical number to
know and not just for publicly traded companies. In fact, in the startup world,
market valuation is paramount to spawning growth. However, for a startup, defined
by cofounder of Warby Parkers Neil Blumenthal as a company working to solve a
problem where the solution is not obvious and success is not guaranteed, business
valuation can seem somewhat elusive.
2

Without publicly-traded shares, though, proper market valuation is still possible
and important, often dictating how well a company does in a.) an initial public
offering (IPO); or b.) when put up for sale. The companies examined toward the end
of this whitepaper did one thing supremely well prior to going to market for an IPO
or sale they valued their companies fairly, and because of that, their IPOs and/or
sales were wildly successful and set them on prolific paths.
Understanding what makes up a startups valuation is important, but where does one
begin? The answers lie in key intangibles that must be developed over the beginning
of a startups life.
These intangibles, in place of years worth of financial performance and history, will
eventually drive the market valuation. But first, lets examine the traditional methods
of business valuation.
1 Market Value. Investopedia, n.d. Web. 11 July 2014.
2 Robehmed, Natalie. What Is A Startup? Forbes. Forbes Magazine, 16 Dec. 2013. Web.
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How to Value a Startup Business
3 Capitalization Rate. Investopedia, n.d. Web. 11 July 2014.
4 Discount Rate. Investopedia, n.d. Web. 11 July 2014.
Valuation methods
There are two popular approaches taken when valuing a business. While each has
many layers, the basic concepts of each approach are outlined below.
The income approach
This first approach estimates valuation by converting projected earnings to a current
value. Projections are based on a capitalization rate (an expected rate of return)
3
, a
discount rate (converting future income and expenses to a single current amount)
4
,
or a multiplier. No matter the method of conversion, the goal is to determine a
fair value measurement of market expectations to reflect the current value of the
company. Meticulous estimating of the proper level of earnings to combine with the
conversion factor after-tax, pretax, discretionary, or cash flow is key to coming
up with a reasonable value.
The market approach
The market approach is just that it uses prices and other relevant information
generated by identical or comparable market transactions. Simply put, it sets
the value based on what other comparable businesses have been sold for in the
startups geographic area. While this approach seems straightforward, implementing
it can prove difficult if similar business transactions dont yet exist.
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How to Value a Startup Business
5 Valuing Your Business. International Business Brokers Association, n.d. Web. 11 July 2014.
Maximizing intangible assets
In either method for valuation, intangibles will be the underlying assets that truly
boost a companys net worth. For a private startup that has not yet seen major
income growth, intangibles rank with even more importance. Therefore, time prior
to the sale should be spent cultivating those intangibles. The International Business
Brokers Association recommends focusing development efforts on the following
intangible assets when looking to increase the value of a startup
5
:
Develop key employees
A startup must be more than its founder or CEO. When it comes to an IPO, buyers
generally arent interested in paying a premium if the business relies on a single
person, or pair of people, for its success. In order to avoid this situation, its
important that leaders remember to delegate responsibilities and focus on a learning
atmosphere where key employees and staff members have the opportunity to
grow and demonstrate pertinent skills in key functions. A company whos success
is reliant on a team of capable, well-trained employees who collectively carry
a valuable amount of intellectual property not just a single brain will see a
significant impact on its valuation at the time of sale.
Write it down
Document everything. There can never be too much organization or detail. Job
descriptions, operations processes, and strategic plans will become pertinent
information in valuation. Succinctly documented records and plans leave little room
for guesswork when it comes to a potential buyer emulating the startups practices
and growth. Other important records to retain include sales and expense reports,
internal profit and loss statements, balance sheets, and tax returns.
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How to Value a Startup Business
6 Bernabucci, Bob. Improving Your Cash Flow Problems. Entrepreneur.com. N.p., 02 Aug. 2005. Web.
Build relationships
Businesses the world over have been developed simply by creating meaningful,
strategic, and rewarding relationships. Hard assets aside, relationships are key,
and provide a reason for focusing on general principles such as name recognition,
customer awareness and positive reputation building. Each relationship established
becomes a part of a business value. This extends beyond company partners
consider diversifying both supplier and customer accounts, as well.
Improve cash flow
Its been said before, and proved many times over in the business world: cash
is king. Many financial analysts consider a companys cash flow to be the most
important indicator of a startups financial health, so it comes as no surprise that
a potential buyer will be very interested in seeing the true cash flow. Where cash
flows are weak, it requires much more than a quick financial fix startups should be
thoroughly analyzing the companys practices in supply chain, pricing relationships,
and flow of funds from customers in order to take a holistic approach to consistently
improving cash flows.
6
Determine (and stick to) a niche
One of the greatest fallacies of a startup is the attempt to be all things to all
people. Because of the inherent unsustainability of this business model, its likely
to drive buyers away. However, potential buyers are much more likely to pay a
premium for a startup successfully operating in a niche with limited competition and
identifiable barriers to entry.
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How to Value a Startup Business
7 Advani, Asheesh. How to Value Your Startup. Entrepreneur.com, n.d. Web. 11 July 2014.
Truths Behind Valuing a Startup
Startup valuation, with its reliance on intangibles, can truly be more of an art than a
science. Still, there are a few concepts to keep in mind during valuation, described
by Asheesh Advani for Entrepreneur Magazine
7
:
You are what the market says you are
Investors will be the ultimate drivers of valuation. After all, it all comes down to
what the people with the pocketbooks are willing to pay. Oftentimes, a startups
estimation of market value will be above what investors declare it to be worth this
is normal. However, theres hope. Keep reading.
You can tell the market what youre worth
Investors will base their valuation off of information youve provided. If all the
previous intangibles are entered into a fair market value of the startup alongside the
hard assets, it will likely be a well-backed, reasonable estimation. Without a wealth
of tangible assets or a long history of financial performance to base a valuation on,
investors will rely heavily on what the startup broadcasts and in case it hasnt been
said enough, intangibles play heavily into that valuation.
Ask for help
Valuation cannot happen in a silo. And because of the weight that a reasonable
projection carries, its important that a startup brings the right people with the right
skills on board. Valuation firms specialize in determining market rates, and are often
staffed by teams of diverse expertise industry specialists, certified appraisers,
financial consultants, lawyers, and more.
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How to Value a Startup Business
Tips for Valuing a Startup:
the Dos and Donts
Value the intangibles. Determining what sets the business apart is key
to valuation, but in a startup atmosphere, differentiation is difficult
without maturity. Instead, focus on identifying and broadcasting the
intangibles that make the startup a unique competitor in its niche. As
described above, this includes intellectual knowledge, goodwill and
relationships, thorough documentation, and more.
Over- or under-estimate future income. Easier said than done, yes;
thats why consulting a valuation firm can be the best move a startup
makes. Speaking to an advisor or a team of advisors who understand
the industry, market, and existing history of the startup will speed the
valuation process up significantly, and guarantee its accuracy.
Play the comparison game. Use similar businesses in the startups
sector as benchmarks. What are they valued at? What have they sold
for? In addition, consider what it would cost to set up a similar startup
from scratch at this moment. Whats the current entry cost in this
market? Current market conditions should be taken into account when
coming up with this estimate.
Be disappointed if potential buyers value the startup differently.
Its important to remember that every analyst will differ in valuation
techniques. As such, buyers most often come in at a lower valuation
than a startup originally intended. This goes back to sharing the right
information to influence the number in buyers heads.
DO
DO
DOnt
DOnt
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8 Dunlop, Michael. 10 World Famous Companies That Started in Garages. Retire @ 21, n.d. Web. 11 July 2014.
9 Galante, Suzanne, and Dawn Kawamoto. Amazon.com IPO Skyrockets.CNET News. CBS Interactive, 15 May 1997. Web.
10 The Worlds Biggest Public Companies. Forbes. Forbes Magazine, n.d. Web. 11 July 2014.
11 Deffree, Suzanne. Apple IPO Makes Instant Millionaires. EDN Network, 12 Dec. 1980. Web.
Success stories
Its time to take a quick glimpse at some of the most famous startups that made
astronomical strides from meager beginnings in fact, the selection here all saw
their starts in garages of various sizes
8
by making the right moves in valuing their
companies from the start.
Amazon
It seems hard to believe, but Jeff Bezos founded Amazon.com in
1994. Initially started as an online bookstore, he ran it entirely out
of his garage in Bellevue, Washington. It was July of 1995 when he
sold his first book, and his IPO came just two years after in 1997.
Underwriters valued the firm at $18 per share, and with that modest introduction,
investors pushed the price 30% higher. Amazon ended the day $54 million richer.
9
And, theres no secret that Amazon.com is now the worlds largest online retailer,
with a 2013 valuation of $157.5 billion.
10
Apple
The Steves: the late Steve Jobs and his counterpart, Steve
Wozniak, at ages 21 and 26 respectively, gave Apple Computers
its start in 1976 in a garage in Cupertino, California. The
companys initial public offering went out on December 12, 1980
at a modest price of $22 per share, but generated more capital than any IPO since
Fords infamous 1956 debut. The stock closed 32% higher that day.
11
In 2013, Apple
was valued at $483.1 billion, with shares trading over $90 in mid-2014.
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How to Value a Startup Business
12 Kennon, Joshua. Walt Disney IPO Case Study A Look at 56 Years of Investment Returns. JoshuaKennon.com, 20 June 2013.
13 Edmonston, Peter. Googles I.P.O., Five Years Later. DealBook. NYTimes.com, 19 Aug. 2009. Web.
Disney
It might seem tough to think of a time when Disney was a startup,
but at a small house just 45 minutes from Disneyland in Anaheim,
California, The Walt Disney Company launched in a small garage
out back. The year was 1923, and Walt and his brother, Roy, set
up The First Disney Studio with their uncle, Robert Disney, where the first Alice
Comedies (later, Alice in Wonderland) were born. In December of 1957, Walt and
Ron took the company public, setting the price at $13.88 per share.
12
At the close of
2013, Americas largest media conglomerate was valued at $142.9 billion.
Google
A startup that eventually turns its name into a verb might be the
epitome of success. But much like the other startups described
here, Google saw modest beginnings as Larry Page and Sergey
Brin gave birth to Google in Susan Wojcickis garage in September
of 1998. When the project began interfering with their studies as Stanford graduate
students, the pair attempted to sell it to Excite for a mere $1 million. Facing
rejection, they kept the firm running, growing it to an IPO valuation of $85 per share
on August 19, 2004. The IPO turned an estimated 1,000 Google employees into
millionaires, on paper.
13
As of 2013, the worlds most trafficked site was valued at
$382.5 billion.
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How to Value a Startup Business
14 Fahey, Jonathan. Love Into Money. Forbes Magazine, 07 Jan. 2002. Web.
15 The Birthplace of Silicon Valley. The HP Garage. N.p., n.d. Web. 11 July 2014.
16 Sicoli, Carlo. Fun For Profit: The Worlds Nine Biggest Toy Companies. The Richest, 21 Jan. 2014. Web.
Harley Davidson
In 1901, William S. Harley paired with his childhood friend, Arthur
Davidson, to create a small engine to power a bicycle in you
guessed it a garage in Milwaukee. In 1903, they officially
founded Harley-Davidson, one of the most well known companies
for its supreme brand loyalty. The companys IPO didnt come until 1986, and
debuted at a humble $11 per share.
14
At the end of 2013, the firm was valued at $15
billion.
Hewlett-Packard
Bill Hewlett and Dave Packard used an initial private investment
of just $538 to build their first product, an audio oscillator,
in Packards garage in 1939. Oddly enough, one of their first
customers was Walt Disney himself, who used the oscillators
in Fantasia. The HP Garage has since become an icon fondly referred to as the
birthplace of Silicon Valley.
15
After an IPO set at $16 per share on November 6,
1957, HP closed 2013 valued at $62.9 billion.
Mattel
Todays highest-grossing toy company in the world
16
, Mattel
began as a picture frame company run by Harold Matt Matson
and Elliot Handler in a garage in Southern California. To utilize
raw materials to their full extent, the friends began using picture
frame scraps to create dollhouses. It led to impressive growth and public ownership
beginning in 1960. As of 2013, Mattel was valued at $13.6 billion.
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How to Value a Startup Business
Valuing a startup for long-term returns
Despite the strange coincidence of each of the above firms getting started in a
garage, the success of these companies wasnt necessarily determined by location,
but in the fact that their owners recognized the importance of intangibles, learned
how to successfully grow their market share, and were thorough in their valuation of
the companies to guarantee enormously successful returns when the time came.
For a startup, valuation can be an extremely daunting task. A worthy reminder:
valuation cannot happen in a silo. When it comes to properly valuing something as
near and dear to you as your startup firm, its best to consult with the professionals
who manage valuations on a daily basis. Appraisal Economics proudly staffs a
unique blend of experts known for thorough, accurate valuations. Contact Appraisal
Economics today to get started.