What is a valuation?
The valuation of a business is the total value of the shares within the company that someone is willing to pay for them. This is normally priced from the latest investment round.
Why it is important
In simple terms it puts a value on your company that can now be measured. From the moment the business has a value its investors will likely expect that valuation to increase over the next two to three years by raising further funds or by growing through customers or sales. A bad valuation could lead to losses for the owner and possibly an unfair advantage to the investor.
How a valuation is reached
It is in many ways a negotiation with investors. Ultimately it is formulated and decided by the business but you need investors willing to agree with the valuation. When you secure investment you sign a shareholders agreement with that new investor. In this they will agree what the price per share will be. Once the price per share is agreed upon and the agreement has been signed at that point the valuation is established.
The tools and approaches used to measure value
There are myriad ways to value a startup or other business and often a combination of approaches will be used alongside market conditions, forecasts, competition, investor experience and proprietary systems – but here are some widely used approaches that founders at the start of their business journey should understand.
It can be a science and an art
This depends on what stage you are valuing. Valuing is more of an art at seed or pre-seed stage as it is likely the business doesn’t have a scalable and high-growth business model at this point. In this case you are looking at the total market, at the team, at what they're building, and you come up with a view of how quickly they can get there.
For Series A and beyond, however, it is more science because at this stage you should have achieved product-market fit. At this point you should have measurable data within the company.
Valuations can fluctuate
Ideally the valuation should trend upwards but it can stagnate between funding rounds if targets are missed.
Controllable factors that can influence valuation
Team - At early stage making sure the startup has the key team members in place is vital. If the business is missing a core member the valuation could take a hit.
Market - If you are entering a large market like FinTech you can go for a bigger valuation than if entering a niche market. FinTech, for example, is a big enough market to cater for a growing startup and you don't need to win a large part of the market to be successful.
Customers - The quality of customers can be just as important as the number of them. Do you have well known customers? Investors like repeat sales. Are you using a subscription model? In this case investors can understand that, project over a period of years, and understand your customer churn.
IP - It is essential the business has its patents and trademarks filed. These are core assets and if not protected will significantly diminish the valuation.
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