Startup Valuation

A business plan is a formal accounting statement that numerically describes a set of business goals, the reasons why they are believed attainable, and the strategic plan and managerial steps for reaching those goals. Hypotheses and visionary ideas of game-changers must be transformed into numbers and need to be backed by reasonable and verifiable assumptions about future events and milestones. Planning is essential for startups that need to formalize their strategies and economic goals.

Startup profitability is a core issue of financial statement analysis and corporate finance. Economic profitability, deriving from positive marginality where revenues exceed costs, is considered in complementary ways. Return on equity (ROE), Return on Invested Capital (ROIC), Return on sales (ROS), and other ratios are systematically illustrated, together with their interactions. Economic Value Added (EVA) represents the value created over the required return of the company’s shareholders, i.e., the net profit less the equity cost of the firm’s capital. Cumulated EVA builds up the Market Value Added (MVA).

Innovative intangibles typically embedded since inception in startups, foster growth, especially if they are bundled in synergistic portfolios. Digital platforms act as a growth catalyzer that ignites real options, introducing resilience and scalability in the business model. Sustainable growth needs to be ESG compliant, following the patterns of the circular or sharing economy.

Innovative startups are newly formed companies with high growth potential, which usually absorb a lot of liquidity in the early years of life, to finance development, against minimal collateralizable assets. This is unattractive for traditional banking intermediaries, usually replaced by other specialized intermediaries as venture capital or private equity funds, which diversify their portfolio basing their strategies on a multi-year exit with substantial expected increases in value from investments that survive a Darwinian selection. The role of professional intermediaries is often decisive along the selective road from startup to scale-up.

Startups are typically debt-free since they are unable to produce positive cash flows or to provide adequate asset-backed guarantees in the first years of their life. Raised capital is so mainly represented by equity, and its monetary component is the cash reservoir that keeps the firm alive until it reaches a liquidity surplus. Cash flow forecasting is crucial to estimate the financial breakeven (runway cash flow), combining the EBITDA generated (or absorbed) by the startup with its change in net working capital and CAPEX. The unlevered features of the startup imply that its opportunity cost of capital is represented just by the cost of collecting equity. In accounting terms, the EBIT tends to coincide with the net result of the income statement (in the absence of debt service and taxes, due to a negative tax base), and the operating cash flow with the net cash flow. When the startup reaches maturity and financial breakeven, it can start raising debt, so increasing its financial leverage. This represents a mighty milestone that can be reached only by the firms that survive Darwinian selection, bypassing the “Death Valley” (that indicates cash- and equity- burnout), and overcoming the “winter of capital.”

Seasoning startups can afford to collect debt whenever they start creating positive cash, build up worthy collateral assets, and soften information asymmetries. Leveraging growth with debt may increase it, albeit with a correspondent risk growth. Capital budgeting metrics, represented by Net Present Value or Internal Rates of Return, incorporate debt underwriting. This analysis is preparatory to Modigliani & Miller proposition II: as the proportion of debt in the company’s capital structure increases, its profitability, proxied by ROE increases in a linear fashion. An empirical case is provided, starting from a real balance sheet.

This chapter illustrates the valuation guidelines for normal businesses that represent a benchmark even for startups. The valuation of a startup is a key element to attract investors and to monitor value growth across time. Several appraisal approaches are used to estimate the potential fair market value, ranging from Discounted Cash Flows to market multipliers or income/asset-based methodologies. The valuation is complicated by the difficulty to estimate future earnings and cash flows, especially for startups with no track record and uncertain perspectives.

Innovative startups are newly formed companies with no operating profits and history, and with high growth potential, which usually absorb a lot of liquidity in the early years of life, to finance development, against minimal collateralizable assets. This is unattractive for traditional banking intermediaries, usually replaced by other specialized intermediaries as venture capital or private equity funds, which diversify their portfolio basing their strategies on a multi-year exit with substantial expected increases in value from investments that survive a Darwinian selection. The evaluation of the target companies follows traditional methodologies, accompanied by specific features deriving from varied probabilistic scenarios and multiple exit methods. The technological footprint implies evaluation analogies with patents, know-how, and intangibles linked to specific sectors (biomedical, Internet, etc.).

Financial technology (FinTech) is an industry composed of diversified companies that use technology to make financial services more efficient. FinTech is recognized as one of the most critical innovations in the financial industry and is evolving at a rapid speed, driven in part by the sharing economy, favorable regulation, and information technology. FinTech promises to disrupt and reshape the financial industry by cutting costs, improving the quality of financial services, and creating a more diverse and stable financial landscape. With the advances in e-finance and mobile technologies for financial firms, FinTech innovation emerged after the worldwide financial crisis in 2008 by combining e-finance, Internet technologies, social networking services, social media, artificial intelligence, and big data analytics. The valuation of FinTech companies concerns promising startups and some seasoned firms. FinTechs have a hybrid business model, as they operate in the financial (banking) sector deploying their technological attitudes. Evaluators may so wonder if FinTechs follow the typical evaluation patterns of bank/financial intermediaries or those of technological firms. Preliminary empirical evidence shows that the latter interpretation is the one consistent with the stock-market mood, and the business model of FinTechs. The appraisal methodology may conveniently start from a strategic interpretation of the business model to extract the key evaluation parameters to insert in the model. Evaluation patterns typically follow Discounted Cash Flows (DCF) or other metrics based on market comparables.

This chapter goes beyond the traditional model of for-profit startups, showing how Microfinance Institutions—a good template for NGOs—can follow the typical startup patterns, with some adaptations. Microfinance is a renowned albeit controversial solution for giving financial access to the unbanked, even if micro-transactions increase costs, limiting outreach potential. The economic and financial sustainability of Microfinance Institutions (MFIs) is a prerequisite for widening a potentially unlimited client base. Automation decreases costs, expanding the outreach potential, and improving transparency and efficiency. Technological solutions range from branchless mobile banking to geolocalization of customers, digital/social networking for group lending, blockchain validation, big data, and artificial intelligence, up to “MicroFinTech”–FinTech applications adapted to microfinance.

Digital platforms broadly represent the environment in which a piece of software is executed, typically online, through a browser. Platforms can also be interpreted as bridging nodes that connect other virtual or physical nodes (e.g., an e-Commerce platform intermediating between a seller and a buyer in a B2C transaction). They can reshape physical supply and value chain, reengineering their processes, and improving the overall resilience. Networks are a powerful catalyzer of interactive activities (exchanges of information; transactions, etc.) that can be boosted and scaled up when they are digitized. Platform nodes may be evaluated considering the Internet traffic that they generate, and the scalability impact of their application, following Metcalfe’s exponential patterns. Platforms do not represent a specific industry or business segment, and they rather refer to a cross-sectional business process that encompasses different industries and products. Startups interact with platforms in a digital ecosystem populated by connected stakeholders that pursue value co-creating strategies. Platforms represented by a legal entity are born as startups and, if successful, quickly scale up and consolidate.

An over-the-top (OTT) media service is a streaming function offered directly to viewers via the Internet. OTT bypasses cable, broadcast, and satellite television platforms, the companies that traditionally act as a controller or distributor of such content. Video on Demand (VoD) allows to play-back digital content whenever and wherever the consumer wants. This industry is relatively young and rapidly evolving. It is so unsurprising that many innovative firms are still in their infancy, belonging to a startup phase. Cutting-edge applications offer entertaining solutions for Internet streaming, disintermediating the supply chain. Smartphone access to the web is eased by tailor-made M-Apps. Social media contribute to the virality of popular media content. The analysis of the innovative business models is a prerequisite for the appraisal of video on demand platforms that embed scalability options. The evaluation depends on the prioritizing identification of the crucial value drivers. The evaluation metrics are mainly based on expected cash flow and market comparisons.

E-Health is a healthcare practice supported by electronic processes and communication that covers everything related to medicine and computers. Complementary telemedicine is the distribution of health-related services and information via electronic information and telecommunication technologies. This industry is relatively young and rapidly evolving. It is so unsurprising that many innovative firms are still in their infancy, belonging to a startup phase. Cutting-edge telemedicine applications aim to achieve optimal patient care and outcomes. They offer indispensable tools for home healthcare, remote patient monitoring, and disease management. A patient-centric vision orientates the strategies and the corporate governance patterns of the composite stakeholders. The analysis of the innovative business model of an e-Health startup is a prerequisite for its appraisal and embeds scalability options. The evaluation depends on the prioritizing identification of the crucial value drivers. The evaluation metrics are mainly based on expected cash flow and market comparisons.

Food technology (FoodTech) is a branch of food science that deals with the production processes that make foods. AgriTech (AgTech) is the use of technology in agriculture, horticulture, and aquaculture to improve yield, efficiency, and profitability. Agritech can be products, services, or applications derived from agriculture that improve various input/output processes. Investments in FoodTech and AgriTech will continue to increase to help deliver on the promise of healthier, more sustainable food systems and more efficient supply/value chains. Startups challenge incumbent food producers and offer digital solutions or other innovative results. The analysis of the innovative business model of a FoodTech or AgriTech startup is a prerequisite for its appraisal. The evaluation depends on the prioritizing identification of the crucial value drivers.