How to Value a Startup Part 3: Keeping Up With the Joneses

I should have listened to the critics and skipped the movie I watched yesterday evening. Had I heeded Ebert and Roeper’s thumb advice, I could have spent those 2 hours doing something far more productive. Or at least far less irritating.

Wouldn’t it be great to have a business version of film critics who could give you a “thumb’s up” or “thumb’s down” on an investment? While it’s not as easy as that, part of the role of valuing a start-up before investing is to give you exactly that “go/no-go” advice.

Before you put your money into a start-up, you want to understand what it is worth. We’ve been writing about a “collage” method of valuation as being among the most accurate valuation methods. A collage valuation doesn’t rely on just one number, but on several numbers to help you know the value of the start-up.

In our last post on the topic, we talked about a basic “assets versus liabilities” calculation. On its own, that calculation is largely insufficient. But it is a start. And when you add it to other calculations, the picture becomes clearer.

Another valuation method is to compare the start-up to the price of similar, established businesses. As Asheesh Advani points out in his Entrepreneur.com article “How to Value Your Startup,” comparing against the purchase of similar businesses allows you to see what other people are paying for similar businesses. [1] He points readers to BizBuySell.com and BizQuest.com, to which we would add BusinessesForSale.com.

Another place to find helpful information about business value is to search publicly traded investments on Yahoo Finance. Information about publicly traded companies is gathered there, including valuations like Market Cap, Enterprise Value, and Price/Earnings ratio. As well, these companies provide a number of disclosures, including income statements, balance sheets, and cash flow which allows you to see what the market is paying for a similar product or service. I suggest to start on the NASDAQ, where smaller businesses that are more frequently nearer to “start-up mode” reside.

Find businesses that are offering a similar product to a similar market niche. Look for at least 3 businesses, perhaps more if possible, and take into account how long they’ve been in business. In some cases, if the start-up you’re looking at is creating something new, you’ll need to make your best guess at the next closest thing. Fortunately, though, you can approach this effort with far more confidence because it is not the only number you’ll be basing your decisions on: So far, you’ve looked at assets versus liabilities and you’ve looked at comparable businesses for income and market projections.

You’ll end up with a range of numbers from businesses that have some similarities to the start-up. Without a doubt, there will be some fundamental differences but this second-of-many valuation “snap-shots” will help to frame your expectations.

Note:

[1] How to Value Your Startup