How to Value a Startup Part 7: Simple Simon Met a Pieman

“Would you rather have a big piece of a small pie or a small piece of a big pie?” was the question posed to me early in my career. I always wondered: “Exactly how big are these pieces of pie?

That is the question in this post; the next in a series of posts (part 1, 2, 3, 4, 5, 6) about valuing a startup.

Venture Hype embraces a collage model of valuations, encouraging angels (and business owners, too) to generate different “pictures” of value that each contribute something to an overall idea of what a startup is worth.

This week’s contribution to the collage is the “pie” model. Have everyone in the startup bake a pie. Then try to sell them. Then multiply those amounts together and you’ll have a realistic value of the business in 10 years.

Just kidding, that is probably the worst advice anyone could ever give. Actually, the “pie” valuation model we’re talking about is where you place a value on the company based on the size of the market and potential market share.

The startup founder will tell you that the market is massive and made up eager clients who are underserved, and that the startup itself will rapidly lock onto a high percentage of market share. You’ll need to ignore them and do your own figuring. And if you’re positive that you’re looking at a game changer that has no competition, think again — even game changers compete with how things are done traditionally.

Start by looking at the size of the market. This will take a bit of research (sorry) in sources like government data, for-profit and non-profit research companies, and industry-specific organizations or associations. When assessing market size be sure to take into consideration current and future reach and distribution channels. There might be a small market now but a larger one later when the company has a more robust distribution network.

Find out:

• How much is it worth?
• What are the prospects in the future?
• Is it expanding or shrinking?
• What are some of the competitors forecasting?

Then, you need to take the even-more-difficult step of estimating market share. Market share (along with all the other great buzzwords like wallet share, mind share, and even the beverage industry’s “share of throat”) can be estimated by looking at:

• How many competitors are in the industry already
• How many non-competing replacement products are threatening the industry
• How many more competitors or non-competing replacement products could enter the market in the next 5 years
• The perceived value of the startup’s products compared to the perceived value of the competition’s products
• The cost and challenge that lies ahead in breaking consumer habits or educating consumers to choose the startup’s products over the competition’s

And the number you end up with? Well, you’ll have a great big market size number and an approximate (and hopefully realistic) market share percentage range. Together, those numbers should help you estimate the value of the company based on whether it grabs a big piece of a small pie or a small piece of a big pie.

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• Image Credit: net_efekt