Is it or not about the Numbers?

The Gordian Knot of Startup Valuation.


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By Simon Thorpe, Chair Cambridge Angels, Angel Investor, Partner Delta2000, and Stelios Kavadias, Margaret Thatcher Professor of Enterprise Studies in Innovation and Growth, Co-Director of Cambridge Judge Entrepreneurship Centre.   

Key takeaways:

  1. Investment decisions in early stage startups face a crucial challenge: the lack of credible output, and the uncertainty of how to get it.  

  2. It is the lack of precise information that makes valuation an approximation process: thus, it cannot be about numbers alone; different and more indirect information signals ought to be looked at.     

  1. A framework of key dimensions is proposed based on past and present successful investments.

Sooner or later during any new startup’s life, the ‘v’ keyword will be spelt out: how valuable is the company? The question is far from theoretical. It actually concerns many aspects of any new business. The value of a company determines its ability to ensure returns to its founders and investors. It allows the capacity to seek further investments, and overall it reflects the real deal: unless the value goes up this means that most likely the startup fails to get traction with the market. 

Given valuation’s central role, one would expect that the question of how to value a new startup has, by now, found an answer. Investors must be using some sophisticated tools! Academics must have derived an (almost) optimal process to deal with valuation! Or maybe not? Unfortunately, reality is more complex. Valuation remains to date a complex process. Experienced investors parallel it to an art. 

There are several reasons why this is the case. Early-stage startups are essentially underdeveloped ideas and experiments that hold promise for big changes, and therefore sizeable returns. But therein lies the essential challenge: they hold a promise. There is little guarantee that this promise will turn into actual returns, a possibility that muddies the optimism. Moreover, this promise is viewed completely different by the involved parties. Oftentimes founders hold on to cool technologies that they understand better but are not able to translate into tangible impact to specific business dimensions – especially in the earlier stages of a new company. At the same time, experienced investors are usually better positioned to assess the competitive impact of a startup within the business landscape. Overall, founders and investors face a level of bilateral information asymmetry that makes it hard for them to hold a similar price tag for the value of a startup.  

At this point, one would exclaim that the presence of such risks cannot be making startup valuation so difficult. After all the financial markets and the institutional investors have established many sophisticated tools of how to value assets. Asset pricing is a long standing topic in the discipline of Finance taught in all top business schools across the world! While it is true that asset pricing has made significant advances, it still relates primarily to tangible assets. But early stage startups seem to lie beyond the complexity of most valued assets out there: they are primarily intangible; they are ideas that hold promise. As a result, their valuation becomes less of a science and more of an art. It reflects more the negotiation between different stakeholders, and less the outcome of a sophisticated financial toolbox.

Still, the challenge remains from a practical standpoint: how shall we be thinking about the value of startups? Truly enough, we may not have as robust information as for other assets out there, but does this imply we cannot/should not value them at all? This is where practice, and in particular the practices applied in business angel ecosystems offer useful insights. Business angels have collectively created an informal institution whereby investments happen in early startups, kickstarting success stories before the rest of the investment and business players appreciate and engage with them. 

Looking more closely at various business angel investment decisions, one can unlock the first insight regarding startup valuations: they are rarely unidimensional. Those valuations do not depend on only the technological IP held by the company, or only the possible market size the startup tries to capture with their offering. Instead, they rely on several different dimensions. This makes sense once we account for the level of risk that such early stage investments assume. Since it is impossible to know a priori how a startup’s offering will evolve and the exact dimensions that may turn it into success, business angels try to account for several proxies that could identify a successful outcome. Proxies that relate to the uniqueness of the startup, but as well as to the peculiarities of the industry the startup tries to enter, and the market it tries to capture.  

A second insight becomes apparent through the examination of the different criteria used to value a startup: intangibles matter! A lot! In particular, the team competencies and its composition in terms of skillsets. One could even try to account for the so-called chemistry of the team. Taking a startup forward is a highly non-linear process with many ups and downs and several moments that can be almost nerve racking. Under such circumstances founding teams that can effectively collaborate but also stand together increase the survival chances of the company. So, a startup’s value is inherently linked with the capability, experience and chemistry of the team.

  • Those two insights start laying down a list of possible valuation criteria, which we present hereafter. These are based on past experience but also multiple discussions with business angel investors. 
  • We have already mentioned the founding team as a valuation dimension. A diverse, skilful team with a strong collaborative spirit can effectively address adversities and failure and pivot towards successful offerings and markets. 
  • The venture’s core technology and its ability to patent/protect it. Whereas not all new startups would enjoy intellectual property protection, the possibility of owning proprietary IP increases the value.
  • The market size the startup’s offering can effectively address. The larger the market, and the more affluent it is, the higher the chances that a successful offering can recoup higher revenues, which in turn signify high investment returns. Obviously, the market size depends crucially on the distinctiveness of the startup’s value proposition.  
  • Yet, capturing the market is not only a matter of the market’s existence but also of the way the startup team will set their business – what has come to be known as the startup’s business model. New companies de facto lack all necessary resources and expertise to make the end result happen. Thus, identifying resource gaps, and describing how they can properly resource their delivery (e.g. partnerships) is a crucial indicator that can point to a higher or lower value company. 
  • Finally, an important dimension to also consider is the unit economics of the business model, that is the per unit startup’s revenue and cost models, which can indicate whether the company can meaningfully scale their business: increasing revenues without an explosion of the cost base. Such a promise increases the startup’s value.

Does our list guarantee the best valuation? If “the value of an idea lies in the using of it,” as famously quipped by Thomas Edison, any valuation can only be validated when the offering is in the market and customers are using it. Until then, we all need to accept the limitations of any valuation scheme, and try to assess a startup from multiple dimensions. 


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