In the Seattle area where Synergetic Finance is based, many small technology firms get started, and we often meet entrepreneurs who are seeking capital, working with limited resources, and looking to grow their new companies. This start-up process all begins with seeking expert advice on business valuation. Regardless of size and industry, many types of firms are also looking to understand value for a number of different purposes. While the situations may vary considerably, valuation work follows specific processes and procedures, and valuing a start-up organization is no different. It is helpful to think of the primary methods used in performing a business valuation and how they might apply to a start-up situation: the income method, asset method, and market method.
The first question we ask for a start-up valuation is “How much money have you put into your company?” Many start-ups have yet to book any revenue and usually have a large number of upfront costs. Income based methods apply valuation methodologies by estimating future growth rates of profitability within a company. These methods are challenging to apply to start-up situations due to not having historical profitability upon which to base future growth rates. Early stage companies pass through four distinct phases: up-front costs, revenues, break-even, and profitable growth. Some start-ups pass through these phases quickly, where others may take a few years or more. However, it is possible to value businesses using discounted cash flows based on reasonable forecasts. Cost based methods may also be helpful to use when owners seek to exit the business before revenues exist. It is useful to understand what has been invested in the business to estimate potential deal values and run acquisition scenarios. A key selling point to illustrate to interested buyers is the benefit of buying a company that has already invested in initial start-up processes.
Secondly, valuators evaluate asset value methods in appraising start-up situations. However, at the start-up stage, the company may have few tangible assets unless they have invested initial capital to acquire company assets. For a new manufacturing plant, asset methods may be more applicable due to buying tangible equipment assets. Building both tangible and intangible assets helps drive a company closer to sustainability, and valuators seek to understand how the assets are generating revenues. Intangible assets are often developed by start-ups and mainly include intellectual property creation. For example, technology start-ups spend time developing software, copyrights and patents to protect and grow their investment in the market. In our experience, most business plans from new Seattle technology firms include some element of intellectual property. These intangible assets help to build companies in early stage development and can be a critical part of the business growth strategy.
Lastly, the question that most applies to start-up valuation is “How does the market view your company and industry?” Most start-ups rely on market methods, in combination with income methods, to value their companies because comparable market sectors can be analyzed for their product or services as benchmarks. Comparing relative risk and growth of your company to the market is the most reliable way to estimate value in the early stages. However, with little operating history, it is only a general estimate based on comparable patterns. While it is admirable to have early stage work pay off, it is important to understand common trends of growth and the likelihood that the growth will continue to build a consistent company future. Just because an industry is white hot, does not mean the business value is sustainable. Within new industries where there are a limited number of companies in the marketplace, this method helps solidify business model assumptions by comparing to similar industries.
Establishing value for start-up companies is challenging due to the high risk nature of most new ventures. Acquiring, investing and working in start-ups may lead to large financial benefits due to effective risk management. Start-up companies may grow quickly or lose money quickly and consequently have higher risk. We advise owners to build stable operating histories and acquire assets that have sustainable value. Market values may change quickly, value may be highly illiquid, and it could be a risk to develop companies with large cost outlays and no asset development for a significant period of time. Building reliable profitability is important for the most accurate valuations.
To summarize, solidifying and increasing business value in a consistent way is critically important for companies of all types and sizes, from start-ups to established brands. If you would like to further explore how a Business Valuation can help you, please call Synergetic Finance at 206-386-5455 or send us an email. We’d love to help!
To your success,
Mark Girouard, MBA, AVA, CMA&A
Synergetic Finance