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    Startup Valuation: How to Calculate Business Cost?

    Probably, every CEO during crowdfunding asks what kind of funding will be required for this. In order to find it, you need to conduct a competent startup valuation.

    In a nutshell, this is an opportunity to determine the cost of a business based on indicators such as expected revenue, potential risks, sources of profit and loss, etc.

    In this material, you will learn about methods for estimating a startup. So let’s get started!

    Let’s take a closer look at all the aspects that need to be considered when evaluating a brand new product.

    Principles of evaluation

    At the beginning of the journey, your project can boast an inspired team and a strong idea. As for the budget, it will grow with time. Therefore, in order to understand how your business develops, and how big will be the budget, consider similar cases.

    Development team location

    The first thing that comes to mind when assessing the startup is developer rates. In particular, as practice shows, the cost of the same project implemented with the help of a similar stack of technologies by specialists from the USA, Australia, Canada, and Western European countries can dramatically (several times) differ from the cost of the project on which their colleagues from Eastern European countries worked (the rates of American specialists start at $60 per man-hour and can grow as the level of their expertise increases; at the same time, the average rates of Ukrainian developers fluctuate between $35-40 per man-hour — the benefits are obvious).

    That’s why having a limited budget (which is typical for the vast majority of starting projects), their CEOs are better off immediately resorting to outsourcing and finding a dedicated team with whom they can interact remotely.

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    Market condition

    Competition can be attributed to the market conditions. If a business offers a unique product its cost is high.

    Thus, if you present, for instance, an application with no analogs yet and which helps users to solve their pain points or entertain them, then your startup is looking better to investors.

    Team

    The team is important too – enthusiasts who will constantly improve and promote the business. Experienced investors always look at the people they are investing in.

    Typically, when the project has only an idea, a business plan, and groundwork, the attracted funds can be not enough. But when the business has its first customers, sales, and traffic, the budget can rise.

    Popular Product Assessing Methods 

    Let’s consider how to estimate your project idea using the well-known approaches. 

    The first Chicago method

    It is based on assessing the startup and the share of the investor in accordance with the analysis of scenarios. This approach involves forecasting optimistic, realistic, and pessimistic scenarios of profit dynamics.

    The real options valuation method

    This approach will let you predict the nonlinear future of the startup and calculate the average of the options, financial contracts with the help of which you can sell or buy assets at a predetermined price up to the expiration date. Real options are not traded in the market as securities and are not linked to securities as underlying assets.

     

    Since options are a flexible financial instrument, a combination of loan options and investments in risk-free assets, it is possible to design portfolios that duplicate cash flows in a very large number of situations. In addition, options imply the allocation of a risk premium to the investor. If we consider the use of one option, then the premium for it is equivalent to some initial investment in the project, the duration of the option is equivalent to the duration of the project or the duration of some uncertain situation, and the strike price is the expected outcome of the project.

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    Scoring method

    It helps you to assess the potential of the project team. It is especially relevant in the early stages of valuation, as the investors familiarize the team as the most important thing in the success or failure of a startup.

    In particular, you need to compare the project with other already invested ones and adjust their estimates in accordance with the following aspects:

    • Management
    • Potential market
    • Innovativeness
    • Number of competitors
    • Availability of marketing and distribution channels
    • Funds need
    • Other factors

    Common Mistakes You Can Face Developing Brand New Products

    Next, we’ll discuss the most common mistakes CEOs make.

    Lack of preparation

    It seems to be an obvious thing: every startup (regardless of scale and ambition of its owner) should always have a well-designed, clear pitch deck and, preferably, a website plus a working layout or an MVP. Surprisingly, not everyone understands this and many projects do not have a complete set of these requirements or it needs serious revision.

    Weak pitch deck

    The pitch deck must be well-composed. A good and understandable description of the product, target audience, market, competitors, financial indicators and forecasts, development plan, and team. A standard pitch deck should contain the most important information about a product; details are best disclosed in a presentation. All amounts are best written in US dollars or euros if you plan to enter global markets or attract foreign investment.

    One piece of information for everyone

    Innovative products often prepare one piece of information for everyone: investors, partners, customers, and the media. Although each of these groups needs to be conveyed a different value. What is important to an investor may not be important to your client. Take one day and prepare information for each stakeholder group. This will make your life much easier.

    Poorly researched market and competitors

    This is one of the most common mistakes, especially when meeting with investors. Innovative products often overestimate market volumes or do not fully understand their own market. This raises many questions from investors and, as a result, doubts. It’s the same with competitor analysis. Therefore, it is important to carefully analyze everything and show real numbers before the presentation.

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    Arbitrary investment amount

    Many projects, especially in the early stages, overestimate the required investments. At the same time, they cannot always clearly explain: what these investments will go to, the cost of a startup, and what share they will give in return for investments. This always scares off seasoned investors.

    Misunderstanding your client

    At the early stages of development, most projects often do not understand the problems of their customers or generally choose the wrong target audience. That is: the product is good, the technology and the team are too, but there is no particular interest. Here it is worth considering whether you have chosen the right target audience. However, sometimes the problem lies in the wrongly chosen monetization model.

    Poorly calculated financial model

    Calculating a business model is not easy, but necessary. Especially if the startup is attracting investment and planning to conduct an assessment. Separately, we note in today’s realities the importance of calculating the burn rate (the rate at which a company is losing money) and monthly operational expenses.

    Therefore, investors need to clearly understand how much a startup spends per month and for what period you already have funds.

    The prototype/product is not developed 

    A common situation: software products at the stage of prototyping an idea cannot correctly calculate the cost, terms, and the required team for the development of a prototype/product. Thus, they are not ready to implement their ideas.

    Summary

    Now when you have learned the basics, you can take a more confident position in negotiations with investors and better understand what exactly needs to be done to grow your business. After all, the most important thing for a founder is that his business develops and makes a profit.

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