Decoding Startup Valuations with the Venture Capital (VC) Valuation Method

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Hey there!

I have been speaking with multiple founders and found that they always wonder about how the VC firms come up with the valuation number for a startup, What are some of the methods they generally used to calculate it and can I calculate it? If you also have this question, I hope it will get clear in this newsletter. I will try to answer each of these questions with a simple example to get a clear idea.

So, when it comes to determining the value of a startup, venture capital firms have a wide array of methods at their disposal. From the Berkus Method to the Scorecard Method, and from Comparable Company Analysis to Precedent M&A Method, there are various approaches to calculating startup valuations based on their stage.

However, one method that holds significant importance in the venture capital world is the VC Valuation method. This method is commonly used by VC firms, especially when evaluating pre-revenue stage startups with an eye on future exits. In this newsletter, we'll take a deep dive into the VC Valuation method, demystifying its mechanics with the help of a simple example.

So, grab a cup of coffee and get ready to unravel the mysteries that lie behind those intriguing valuation numbers!

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The VC Valuation method is generally used by VC firms to evaluate pre-revenue stage startups with an eye on future exits. It generally comprises 6 steps:

1. Estimate the capital required for the startup

2. Financial Forecasting

3. Timing of VC Exit

4. Multiple at Exit

5. Desired Rate Of Return of VC

6. Ownership stake of VC Firm

Let’s understand this with one simple example,

Example:

Suppose a start-up looking to raise $5 Million and has a total of 1M shares outstanding.

After doing financial forecasting you find that the startup’s EBITDA after 5 years is $12M. And VC firm also wants to exit after 5 years.

And EBITDA Multiple = 7X (Industry Multiple for most of the startups)

So at the time of exit the startup will value at = 7 * $12 M = $84 M

and Desired VC Rate of Return = 30%

Future Value of Investment =

$5 M * (1+30)^5 = $18.6 M [ Considered As FV = PV *(1+R)^t]

Hence the required ownership by the VC firm = $18.6 M / $84 M = 22.1%

The post-money valuation of the company (PV) = $84M / (1+30%)^5 = $22.6M

Pre-Money Valuation of company = $22.6 M - $5 M = $17.6 M.

Hence $17.6 M is the current valuation of the startup considering the future EBITDA Multiple and other assumptions.

Also, outstanding share = 1M

Price Per Share = $17.6 M / 1M = $17.6

Total Number of Shares Post Money = $22.6M / $17.6 = 1.28M

That's it about the VC valuation method. So simply follow the six steps you will easily come up with the startup valuation number.

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Also, don't forget to join our Slack community, The Venture Crew, to connect with like-minded startup enthusiasts and founders.

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