What You Should Know About Valuation of Startups

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What You Should Know About Valuation of Startups

By CFO Tech Outlook | Tuesday, February 23, 2021

Start-ups can use EBITDA-based evaluation to increase sales and maintain low costs. 

FREMONT, CA: The earnings before interest, tax, depreciation, and amortization are known as EBITDA. For now, companies can approximately picture EBITDA as an annual net profit. EBITDA-based valuation is rarely utilized in the start-up software environment and is more popular for an established company such as a physical store or a service company. In order to increase sales while maintaining low costs, the valuation can be decided based on the productivity of the business.

Valuation based on revenue and growth

In the software start-up environment, valuations based on sales and development are more generally measured. These start-ups normally grow very rapidly and use all their money to expand much faster, implying that there is rarely any if any profit. Users take the income of the start-up and multiply it by a multiple to calculate valuation utilizing this methodology.

A start-up growing at 40 percent per year can get a multiple of 6 to 10, while a business growing at 10 percent can only get a multiple of 1 to 2. In these calculations, high growth will help boost the valuation of the start-up.

What about pre-revenue or early revenue start-ups?

If there is no revenue or early days, and the start-up does not have any revenue yet, estimating value becomes more challenging. Sometimes, a convertible note is used in such cases. A convertible note is simply a loan that transforms into equity for the loaner during a stage in the future.

Convertible notes at an early-stage start-up are more manageable, quicker, and usually cheaper (in terms of legal fees) than an equity investment. There are also potential benefits in terms of taxes and not giving away any leverage in the start-up.

SAFE (simple agreement for future equity)

The Secure agreement created by Y Combinator has been a common alternative to convertible notes in recent years. They are somewhat like convertible notes, but they do not accumulate interest and are not a loan. However, they are simpler and easier than a convertible note to enforce.

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