Valuing Your Startup

All people working in the Startup / Early Stage consistently asked the same question,
"How do you value a business?"

The correct answer is there is no correct answer.

Remember that valuations are 'forward looking' not 'backward looking'
e.g. next years sales not last years sales

Here is a number of models that may help.

1. Sales Revenue
Often businesses are valued based upon revenue.
This means a business with $1 Million revenue would be valued @ $750,000 to $1,250,000
or values each dollar sales between $0.75 - $1.25

Several open source and web companies have been being sold for 10 times their subscription revenue.
e.g. Sun purchases MySQL

2. Price Earnings Ratio
This is the number of years of after tax profit it takes to return your investment
A typical private company sells for a PE of 2-5 where public companies sell for 8-20.
Google sells with a PE 48

Many people use EBIT, Earnings (profits) Before Interest and Tax as a measure of how much extra debt a company can take to help pay for the take over.

3. Discounted Cash Flow (DCF)
This technique combines all the cash generated from the business and then discount
(reduces) them to a present value. (i.e. A dollar today is worth more than a dollar tomorrow)
This can be a problem if the wrong interest (discount) it used.
BTW, The interest rate is ALWAYS WRONG

4. Replacement Value
How much would it cost to get similar stuff either new or used?

In software, many people use COCOMO which is a formula that counts lines of code and examines the complexity of code thereby allocating a amount of developers time it would take to replicate it.

SLOCCount Is a free COCOMO tool that supports about 27 different languages.

For many software startups this is a good starting point.

5. Return on Investment (ROI)
This combines a number of the above techniques to derive a single figure.

Many early stage investors Angels / VCs demand +45% ROI as compensation for the higher risk associated with early stage. This is a serious market failure. If the market was better informed the Cost of Capital should be around 18% (similar to a credit card).

A team of 3 developers have written 13K lines of PHP source code to develop a DIY superannuation management software. It has taken 6 months part time (ie 50 hour/wk)

They are all leaving their "real" jobs to pursue their dream.

Sales: Nil

User: 250

Total Cash Spent: $5,800

What is the company worth?

1. Sale Revenue Nil

Future Sales Revenue 2009 $1,000,000 (FV)
Discounted @ 40% pa $510,000

Company valuation $383,000 - $637,000

2. Price Earnings

2009 Sales $1,000,000
2009 Profit $180,000

PE 2 (180K x 2 x 40%) $183,000
PE 5 (180K x 5 x 40%) $459,000

Company valuation $183,000 - $459,000

3. Replacement value $413,228

The following output is from a real project

Totals grouped by language (dominant language first):
php: 13409 (99.83%)
sh: 23 (0.17%)

Total Physical Source Lines of Code (SLOC) = 13,432
Development Effort Estimate, Person-Years (Person-Months) = 3.06 (36.71)
(Basic COCOMO model, Person-Months = 2.4 * (KSLOC1.05))
Schedule Estimate, Years (Months) = 0.82 (9.83)
(Basic COCOMO model, Months = 2.5 * (person-months
Estimated Average Number of Developers (Effort/Schedule) = 3.73
Total Estimated Cost to Develop = $ 413,228
(average salary = $56,286/year, overhead = 2.40).

As you can see there is no right answer but all valuations are more art than science.

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