| Traditional methods can be used to value companies | | | | internet. They can expand and grow globally very |
| with track records of revenues and profits, but they | | | | fast compared to other sectors, that too with a |
| are ineffective for determining value of a start-up | | | | very low capital base. Moreover, their gross margins |
| company. Too many assumptions of moving variables | | | | can easily range between 70% and 100%, as against |
| make valuing early ventures using these methods | | | | commodity companies that run on low margins. |
| useless. | | | | Successful ventures can either be sold to larger |
| Determining expected growth rate of revenue and | | | | companies or they can opt for an IPO. Early venture |
| profits is meaningless when the success of a start-up | | | | investors tend to determine two values; the potential |
| cannot be confirmed. A market may reject the new | | | | value at the time of next round of fund raising and |
| product or the regulators might not approve the | | | | the potential value of the company at the time of |
| product in the first place. Moreover, several ventures | | | | exit or sale. They then determine the value of the |
| may be based on new ideas which are not yet | | | | venture today to get an idea of the multiple they |
| tested and do not have an established market. | | | | would gain. This method is referred to as 'Venture |
| Valuing start-ups is still important, especially for | | | | Capital Method'. |
| investors as it helps them in deciding the percentage | | | | For valuing a start-up, a venture capitalist also |
| of ownership they will receive. Investors in early | | | | depends on his intuitions and knowledge and |
| ventures expect to gain a good multiple on their | | | | perception about the industry. Following are some of |
| investment. In other words, the business should be | | | | the important factors which the investor should |
| expected to reach a higher Market-to-Book ratio. | | | | examine while judging the value of an early venture: |
| It is normal for start-ups to lose money during initial | | | | * Valuations of comparable publicly listed companies |
| years. Several new technology companies which are | | | | * Addressable size of the market |
| internet based tend to be loss making even at the | | | | * Valuations of merger and acquisition transactions |
| time they are being sold. While Price to Sales can be | | | | * Gross margins of similar companies |
| applied, it completely ignores the operating efficiency, | | | | * Expected long run growth rate |
| growth rate and relative market size. | | | | * How different is the new product or service |
| It is generally observed that new technology | | | | Several start-ups launch new products and services. |
| companies are valued higher than companies from | | | | In such cases, it is difficult to judge competitiveness |
| other sectors like consumer products, chemical and | | | | of these ventures and valuing them based on |
| other manufacturing sectors. One prime factor | | | | comparative valuations will be inappropriate. Using |
| distinguishing technology sector and traditional sectors | | | | Cash Flow Discounting Model would be ideal in such |
| is that while traditional companies face geographical | | | | cases if it is possible to forecast future cash flows. |
| constraints due to product weight, jurisdiction wise | | | | Several venture capitalists prefer valuing intangibles to |
| regulation etc; technological companies can avoid | | | | overcome the shortcomings of traditional methods. |
| these constraints by using third-party distributors or | | | | |