

How are valuations for startups established? - matth

How exactly do VCs and the like figure out how much a company is potentially worth? X amount of user, demographic coverage + allure, X% growth month-to-month?
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jam
I've worked as an analyst for an early-stage VC firm, and at that stage
valuation is much more an art than a science. With pre-revenue companies,
there are two important questions for the VCs to ask themselves:

1\. How much money do they need? 2\. How large a percentage of equity do we
want?

#1 can be easily determined. #2 needs to be played with a bit, as a good VC
firm won't want to take enough equity to demotivate the founders at all, yet
still wants to see an attractive return (based very roughly on their own
financial projections for your startup).

#1 * 1/#2 = post-money (after investment) valuation

post-money valuation - #1 = pre-money (before investment) valuation

This is, of course, how it works after a firm has decided to make an
investment in your startup. Good VCs won't really even bother with pre-revenue
company valuations until after they've decided that they want to work with
you.

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pg
It's done totally by the seat of the pants, based on how formidable the
founders seem, how sexy the idea seems (as far as the investor can tell), and
above all, how much interest there is from other investors.

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tjic
A profitable company has earnings.

A public company (or even one that has recently sold shares on SOME market)
has a price.

Divide the price by the earnings, and you get the P/E ratio.

There is a range of sane P/E ratios. No stock ever trades at a P/E of 5,000.
1,5,and 10 are plausible P/E ratios.

One rule of thumb (advanced by the Motley Fool guys) is that the P/E ratio
should be about the same as the P/E should be around the percentage annual
growth (P/E/G).

Anyway, let's assume that your startup is going to sell someday for a P/E of
5. That tells us that the price will be 5 times the earnings.

So: tell me what you expect your earnings will be at this future date?

Let's say that you're entering a $1 billion/yr market, and you expect to grab
10% of it: your revenue will be $100 million. You expect that of every $100
that enters the company as revenue, 90% will be spent on salaries, Jolt, and
Aeron chairs. So you've got a 10% profit ratio...and on that $100 million of
revenue, you expect to earn $10 million of earnings.

Jump back to the P/E stuff. If your P/E is 5, then you've just described a
company that might be worth $50 million.

Of course, maybe it would actually be worth $300 million because it's a
strategic buy for someone else. Or maybe it would actually be worth $0,
because it's based on a stupid idea that will be killed by someone else.

...but that's a first stab at the valuation if everything goes right, and the
company succeeds wildly, and someone else buys it at a typical P/E ratio.

There are other valuation formulas, but they tend to boil down to this one at
the base (i.e. the demographic coverage, etc. that you mention are ways to
figure out total market, or your share of the market, etc.)

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falsestprophet
Wikipedia says that a PE-ratio of 14 is average for public companies and that
a ratio of 25 is plausible for a high growth company.

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dcurtis
The P/E for Apple is 40.72.

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rms
With companies that are too new to be profitable, it has more to do with what
the venture capitalist is willing to invest for a certain % ownership than an
appraisal of the actual value of a company.

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davidw
It's a guess by someone with experience making those kinds of guesses.

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ideas101
I hope the following links will help you ...

<http://www.venturehacks.com/term-sheet-hacks>
<http://paulgraham.com/equity.html>

