By Dan Gray
Overall, there is no standardized methodology to calculate the value of a startup. Typically, the market is robust enough – balancing capital and opportunity – that both parties to the transaction are obligated to be fair in their evaluation of the deal and negotiation of the terms.
Founders in developed economies have access to capital from a variety of sources, including alternatives to traditional equity investments: government grants, college scholarships, business loans, venture capital debt, and cash flow financing. There are a range of ways to fuel the growth of a young company, although equity fundraising remains most appropriate for early-stage high-risk ventures and competition for such deals helps maintain an environment favorable to the founders.
The valuation of these equity transactions remains a complex subject, but most of the time, with one method or another, a price is agreed and the market ensures that the price is reasonably fair.
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When capital deployment slows, these operations rebalance at the expense of the founders. There is an impact on transaction terms and valuations, as we have seen recently.
In emerging economies, asset classes like venture capital are not as developed. The pool of investors in contact with startups is smaller, can extract more demanding terms from entrepreneurs and is often less experienced in transactions of this type. Additionally, entrepreneurs often do not have access to the array of alternative funding sources mentioned above, should equity fundraising prove difficult.
The void here is a rigorous and standardized framework for valuing startups, which can be adapted to regional contexts and indicate a “fair market value” for the equity of these companies.
This would achieve several goals:
Streamline the fundraising process for investors and entrepreneurs
If you search for “how to value a startup,” you’ll find a dozen suggested methods, from cost to duplication to revenue multiples. The most advanced approach is obviously to combine several methods, offering different perspectives on the question, but which one? Will your potential investors agree that you did it the right way?
Making investing in startups more inclusive
Being able to confidently evaluate a seed investment, often without much comparable data available for emerging markets, requires more sophistication. This makes some investments less accessible to new investors, slowing the pace of market change and limiting the amount of capital available to startups.
Reduce personal bias in the investment process
Obvious, but worth pointing out: the more the assessment is based on a standardized process, the less chance there is of personal biases creeping into the equation. Knowing it or not, founders and investors can be found guilty of irrational influences on something as complex as evaluating a startup investment opportunity.
Better long-term outcomes for ecosystems
Investors and founders are basically on the same side: both want to build great companies and create value. Valuation is one of the few areas where the two sides diverge, with competing incentives for ownership. Building the relationship on open standards, especially when it comes to resolving sticking points, is sure to make overall engagement more positive and enable healthier, more collaborative ecosystems.
There’s no reason why this proposition shouldn’t apply globally, but that’s a case for another day. This is probably equivalent to trying to shift the world to metrics.
What is clear is that standardized valuation could have a significant impact in emerging markets where there are fewer established practices, less data to compare and greater competition for capital. Fair and transparent prices are the fat of well-functioning markets.
Dan Gray is a consultant working with fintech and Web3 startups, and the head of marketing at Equidama startup assessment platform.
Drawing: Dom Guzman
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