Methods for evaluating a startup. Continuation

    The article is a continuation of the first article in a series of analytical articles devoted to assessing the financial component of a startup, its target audience, designed to help authors of projects.

    From the idea of ​​a startup to getting your first investment, you need to go through several steps. One of them is an adequate assessment of a startup. There are no clear methods giving a reliable figure! But an assessment is needed, both for the investor and the author himself.

    How to get it? ...

    Methods for evaluating startups.


    Experts RVC believe that the first potential of the project is to analyze the business is an expert, rather than technology, at the same time, it assumes that the proposed technology works, and the product has already been created. At this stage, he evaluates the possibility of building a profitable business. Alas, very often projects never reach technologists. Let's look at the most popular assessment methods.

    Cost method (recovery).

    A method that allows you to evaluate the real financial costs of creating a similar project, based on:
    - the current market value of the specialists working on the project,
    - costs of legal and official formalities, licensing, patenting, etc.
    - the assets available on the project, fixed assets, etc.
    - the costs of repurchasing a share from investors of the previous stage of financing.
    - costs of services of third parties associated with the project (custom marketing research, preparation of technical specifications, etc.)
    - current costs of advertising, promotion, recruitment of the project audience.

    Example: (Calculate the cost of reproducing the Twitter or Facebook project yourself and compare it with its current value)

    This method is good becauseIt allows you to evaluate the effectiveness of spending money by a startup team , and is convenient for an investor when trading with a startup with his low price.
    The negative side of this method is that it does not take into account the value of intellectual property, the assessment of the personal initiative of a startup, and other intangible values.
    It serves as the basis for evaluating startups using several different methods.

    The Berkus Method.

    The first time was published in 2001 in the book “Winning Angels” by Harvard's Amis and Stevenson. The main idea embedded in the Berkus method: taking into account the potential of a startup using some empirical coefficients for the recovery method.
    Odds that I come across in open sources:
    • Premium for an attractive idea - 20% - 40%
    • Premium for competent and professional project management - 20% - 80%
    • Professional board of directors, highly qualified project mentor - 10% - 40%
    • The premium for the uniqueness of the market position (participation of state structures, a large strategic partner, a high threshold for entering the market of competitors, etc.) - 10% - 20%
    • Implemented prototype - 20% - 40%
    • CashFlow - 20% - 40%


    Or, as a special case of the method, in absolute terms for projects with a replacement cost from 800 thousand to 2 million dollars.
    Add for $ 1 - 2 million if exists:
    • Great idea
    • Prototype (technological risk reduction)
    • Quality management team (reduced execution risk)
    • Strategic relationship (market risk reduction)
    • Product introduction or start of sales (reduction of production risks)


    The author himself repeatedly reviewed the coefficients, introduced them in percentage form, then changed to absolute values ​​and returned again to percentage. Like any empirical assessment, the method suffers from personal bias and an attempt to adapt to the current market moment.

    The rate of return method (venture capital method) through forward value.

    The calculation of the future value (forward value) of the planned investment according to the formula:
    FV = PV (1 + r) N,
    where FV is the forward value, the future value of the investment (after 5 years)
    PV is the present value, the current investment value
    r is the target rate profitability (IRR),
    N - the period during which the investor's money is working in the project (the number of years before the investor leaves the startup).

    Example: with a 50% annual IRR and investment period of 3 years, the future value of $ 100,000 investment is FV = $ 100,000 x (1 + 0.50) * 3 = $ 450,000.

    Profit rate method (venture capital method) via terminal value

    Calculation of the final value (terminal value) of the company at the exit of the investor. The simplest, but not the most correct way: to spy on the status of a competitor's company, or an analogue company. Then, by a key indicator, or their combination (number of customers, sales, market share, etc.) to determine.

    Example (continued): if the startup’s projected net income after 3 years is $ 100,000., And the average price-earnings ratio for comparable peers is 15, then the company’s projected value after 5 years is TV = $ 1 million x 15 = $ 15 million

    Determination of the required share in the company’s share capital (i.e. ownership share). In order to determine the necessary share in the shareholder’s capital, the future value of the investment (first stage) should be divided by the projected final cost of the company upon exit from the investment.

    Example (continued): Equity (ownership) = $ 4.5 million / $ 15 million = 30%.

    Profit rate method (venture capital method): calculating the pre-investment and AFTER investment value of a startup.

    Example (continued): If 30% of the company is acquired by an investor for $ 1 million, then the full post-investment value of the company is $ 1.00 / 0.30 = $ 3.33 million. The pre-investment value of the company = $ 3.33 - $ 1 million (investment) = $ 2 , 33 million

    Both calculation options using the “Profit Rate Method” estimate not so much the cost of the startup itself as the efficiency of investments in the project . But for a conversation with an investor - is this not the key point?

    A method of evaluating a potential audience at a customer’s cost

    This method can be used to assess the future value of a startup, the success of which is closely related to a recruited customer audience.
    It is important at the same time that the “price” of an individual client does not have a large spread in the companies working in this sector of business. This assessment method is similar to the analogy method, but has more objective results, because with the right approach, you can average revalued and underestimated projects.

    Example: For a startup focusing on the provision of mobile services, the calculation of the client base is the most adequate assessment. The cost of one client for various companies - mobile operators does not have much variation. This option is available in open sources. Having estimated the expected number of project clients in the future period and multiplying them by the current value of the MTS client, or Beeline, you can get the estimated cost of the startup at the time it reaches the planned targets.
    When calculating the current value of the future cost of a startup, it is necessary to take into account risks (from 90% at the Pre-seed stage, to 30% at the growth stage), the cost of money, discounting, etc.


    A method of evaluating a potential audience for customer returns.

    This method is perhaps the most accurate economic method for calculating the future value of the project. It relies on the standard method of measuring business by income (Revenue Method, BSV VII).
    Based:
    • current profitability of one client averaged over the business area of ​​the startup;
    • expert evaluation, or prognostic calculation of the number of clients at a certain stage of the project development, you can calculate its future value.


    Example: The average income from one client of a gaming application to a social network is $ 10 / year. The cost of attracting one subscriber of the gaming application is $ 5. With an advertising budget of $ 50,000, 10,000 subscribers can be expected. Accordingly, the annual income of such an application is $ 100,000 / year. The cost of such a project in 1 year is $ 300,000 (3-fold annual income). The
    exact same calculation can be made through the profit indicator for 1 client.


    The method of assessing prospective value based on the coefficients (multiples) of P / S, P / E, P / B and others.

    The most popular option is the P / S “capitalization to revenue” ratio of two to four times the size, depending on the industry.
    In this case, it will be necessary to compare, as a rule, with the multiples of companies trading on the exchange.
    Application of the method is justified in the late stages of financing.

    Calculation method for the Ave Maria model.

    Ave Maria model (free abbreviation for Acquisition, Value, Engagement, Monetization, Retention, Intellectual Property).
    The author of the model is Maxim Kraynov (Kraynov Investments).
    • Acquisition (Getting new customers or users). What is the audience of the project, what is its size, how can it be described and characterized? Through what channels, partners can the described audience be attracted, how many people can ultimately be attracted as users (customers)?
    • Value (value - the author acknowledges that the term is unsuccessful, Cost costs would be more correct). How much does a visitor cost, how much does a user (client) cost? What is the cost of attracting a user (client) in different channels? What affects the cost of attraction? What is the marginal cost of attraction?
    • Engagement (Involvement of the user (client)). Description of preferred actions for the active and passive user, as well as secondary, side effects. This also includes the interaction of users (customers) among themselves.
    • Monetization (Project Monetization). How will the number and activity of users be converted into project revenue? Additionally, you can describe different methods of monetization for different segments of users. At what point will the user pay for himself?
    • Retention (customer retention). Description of how to make the client return, turn him into a regular user, convince him to pay for membership (status)? All this relates to the topic of customer retention. How will the budget be distributed between attracting new customers and retaining old ones? Comparison of LCV (Lifetime Customer Value - the amount of money brought by the client to your business), the cost of attracting a client and the cost of retention.
    • Intellectual Property. How does a company protect itself from the machinations of competitors and from the fact that a dissatisfied employee leaves and opens a competing company? How can a company protect itself from copying the implementation of a work idea?

    This method does not provide the estimated characteristics of the project, but is convenient for comparing different projects when choosing the preferred investment direction.

    Scoring Method (Scorecard Method).

    The author is investment “angel” Bill Payne. The method is also known as the Bill Payne Method or Benchmark Method.

    This method compares the business you are acquiring with other typical angel-funded startups and adjusts the average rating of recently funded startups in the region to get a startup’s estimate before earning the first income. Such comparisons can only be made for companies at the same stage of development, i.e. before you start earning income. The methodology is similar to the Brooks method, but is tied to specific local conditions.
    1. The first step in using the method is to determine the average company rating in this region and in this sector of the economy. The average score can vary from region to region depending on the state of the economy and the competitive environment for startups. In most regions, this estimate does not vary significantly depending on the sector of the economy. (Unfortunately, in Russia such data are not widely available, but nevertheless, they are already being collected and analyzed)
    2. The second step in determining a startup’s assessment prior to generating revenue is to use the scoring method to compare the acquired company with your data on such transactions with consideration of the following factors and ratios that affect the value of the evaluation:

    • Having a strong management team: 0-30%
    • Market Size: 0-25%
    • Novelty of a product and technology: 0-15%
    • Competitive environment: 0-10%
    • Marketing, sales channels, partnerships: 0-10%
    • Need for additional investments: 0-5%
    • Other factors: 0-5%


    Subjective ranking of factors is typical for investor evaluations of startups. Some may be surprised that the importance of the product and technology is lower than the importance of the management team and market size. In building a business, team quality is the key to success. A good team will be able to detect product shortcomings at an early stage and correct them, and the possibility of increasing sales and scalability of the business is important for future investor income. Good product and intellectual property are important, but team quality is key.

    Example: To illustrate the calculation, take a company with an average product and technology (100% normal), a strong team (125% normal) and a large market size (150% normal). The company will be able to achieve a positive cash flow with a single angelic round of investment (100% normal). Given the strength of competition in the market, the company is weaker (75% of the norm), but the initial consumer reviews of the product are very good (Other factors = 100%). The company needs some additional work in establishing sales channels and partnerships (80% of the norm). Using this data, we can make the following assessment:

    Factors to CompareRangeStartupFactor
    Having a strong management team30% max125%0.3750
    Market size25% max150%0.3750
    Product and Technology15% max100%0.1500
    Competitive environment10% max75%0.0750
    Marketing, sales channels, partnership10% max80%0.0800
    Need for additional investment5% max100%0.0500
    Other factors (good customer reviews)5% max100% 0.0500
    TOTAL1.0750


    Multiplying the sum of factors (1.075) by an average valuation of $ 1.5 million, we get the valuation of the acquired company at $ 1.61 million.

    The key point in the scoring method is understanding the average rating of companies until they receive income in your area . With this data, the scoring method gives investors subjective methods to adjust the valuation of the acquired company for seed and initial investment rounds.

    PVN method.

    The most common startup assessment method is the PVN method. This is a type of expert assessment widely used by Guru IT Co., in particular, according to unconfirmed reports, by Steve Jobs himself (just read the biography of Steve Jobs).
    The abbreviation of this method comes from the first letters of the popular phrase "Palchem ​​v Nebo" .
    Despite its “anti-science”, the estimates obtained on the basis of this method, with good investor intuition, are the most reliable and reliable.

    The choice of the evaluation method used, depending on the stage and direction of the startup
    Depending on the stage of development of a startup, it is advisable to select a method that more adequately takes into account the current stage for its evaluation. Of course, no method will give a reliable assessment of a startup, especially in the early stages.

    In the early stages, we would recommend using predominantly evaluative or expert methods, and in the later stages - using calculation methods.

    To be continued


    If a respected community shows interest in this topic, we’ll cover the following articles:
    • About when to enter the market
    • On identifying and evaluating a startup’s target audience
    • We show on the examples of real startups the calculation of financial attractiveness


    Author: Chernyak Dmitry (business angel, info@findstartup.ru).
    Collaborators:
    • Bobkov Roman (investor, rbobkov@gmail.com),
    • Zhuravlev Ivan (business angel, info@findstartup.ru),
    • Ratunin Oleg (creator of the project napartner.ru, okolovas1@gmail.com).


    PS For an article with calculation examples, you need those who want to evaluate your startup.
    We warn you right away - there will be no freebie. You will evaluate your own project yourself, but under our strict guidance. We will study your project, prepare a questionnaire and help calculate the cost of the project. Those interested can unsubscribe in the comments, or at info@findstartup.ru.
    The most interesting and elaborated estimates will be published on the Habré as illustrations for calculation methods.


    PP S Continuation of the Startup Time to Market series

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