Startups that have long-term potential for growth and profitability frequently leverage funding from investors to reach their stride. A high probability of getting the highest return on their investment dollars is the only objective for many investors. So, how can you accommodate this need when determining a valuation for a startup that isn’t yet generating revenue?
Understanding important financial terms
Free cash flow is an accounting metric used to define financial performance, it is calculated as operating cash flow minus capital expenditures.
Post-revenue value is the value of a company after it has received financing or outside capital.
Pre-revenue value is a term widely used in the investment industry to describe, the valuation of a company that has not received outside investment or financing.
Net present value is the sum of all future cash flows.
Do the math
First, calculate your margins. Be transparent and use the most accurate iterations of your expected revenue and your expenses to get a clear representation of potential free cash flow. This is the first step to making sure your financials are in order. If they aren’t, there are not very many underwriters who will want to touch your startup (you may even consider having an accounting professional model a 409a model if your situation is exceedingly complex).
Use this data to determine your projected terminal value and return on investment (ROI) for a period between 3 and 7 years in the future. Now take the newly defined terminal value of your startup in that period and divide it by the expected (ROI) for that year. The quotient is a valid representation of the post-revenue valuation. Your pre-revenue valuation will be an amount approximately equal to the difference between your post-revenue valuation and any capital you have invested into the company. This process is far from simple, so make sure you are ready to commit a lot of time and resources to getting the most accurate numbers.
Unrealistic expectations may turn an investor off to your idea entirely and you might not get another audition. This doesn’t mean that you should let investors take advantage of you. If your startup shows signs of growth, positive engagement, traction and exceptional projected revenue, never allow negotiations to remain at a stalemate.