Start-ups - Valuation considerations
In addition to general market risks associated with valuing companies, specific risks should be considered in any early-stage company valuation. Failing to appreciate a start-up’s specific risk profile can lead to inaccurate assessment of its full value potential in an exit scenario unless there is sufficient transparency of existing risks and opportunities to promote robust price negotiations. How can this be considered in the valuation approach? Do the special characteristics of start-ups require unique valuation procedures? We examine these questions, discuss the archetypical evolution of a start-up’s risk profile and explore how this can be reflected in valuations through a dynamic valuation approach.
Start-ups – a somewhat traditional asset class
From an economic viewpoint, start- ups are investments involving an upfront payment today – e.g. founders’ labor and intellectual property, the contribution of business ideas or financial resources – with the expectation of receiving (higher) financial resources at a later date, e.g. upon (private or public) sale. How high expected future cash flows should be depends on the perceived level of risk of the founders and investor. It is hardly surprising that the respective parties may have vastly differing opinions as to the future development and financial outcome of an earlystage company. Founders and investors may have greatly diverging views on what should be contributed by each party, and what share in the start-up each participant should receive. Many start-ups already had numerous financing rounds and changes in ownership behind them, especially at the beginning, meaning that issues around proper distribution of value (i.e. financial performance and risk) between the participants are more common than in deals with established companies. Insufficient information makes it difficult to get expectations right and find alignment. With future operational performance still to be proven, the various stakeholders are most likely to disagree on value expectations.
With this in mind, utmost transparency is critical in making valuation assumptions.
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