# Understanding the common startup valuation methods

possibly you are fund lift or considering selling a part of your startup to an investor. Either direction you need to rate your startup to figure out a clean monetary value for the fairness being sold and money being added to the occupation or being taken out by you .
There are a few approaches to evaluation and taking on an investing in your inauguration .

## Valuation based on EBITDA

EBITDA ( pronounce eee-bit-dah ) is earnings before concern, tax, depreciation and amortization. You can approximately think of EBITDA as annual net profit for now. so if your startup is further along and generated \$ 1M ( \$ 1 million ) in profit in the most recent year then a multiple might be used such as 4 and your startup could be valued at \$ 1M x 4 = \$ 4M. If you wanted to sell 25 % of your ship’s company then the investor would pay you \$ 1M as the owner of the ship’s company and they would receive 25 % of the stock. The multiple could vary based on the stability of the business in recent years, emergence opportunities and many other factors. EBITDA-based valuation is rarely used in the inauguration software worldly concern and is more coarse with a traditional business like a physical store or a services business. The evaluation is being determined based on the efficiency of the business to generate tax income while keeping costs low .

## Valuation based on revenue and growth

It is more common in the software startup universe to calculate valuation based on gross and growth. This is because these startups typically grow very fast and use all their cash to grow even faster meaning that there is rarely much if any net income. To calculate valuation using this method, you take the tax income of your startup and multiply it by a multiple. The multiple is negotiated between the parties based on the increase rate of the startup. A startup growing at 40 % per class may receive a multiple of 6 to 10 whereas a company with 10 % growth may only receive a multiple of 1 or 2. eminent increase can in truth drive up the value of your startup in these calculations !

An exercise might be that your inauguration did \$ 3M in tax income last year and did \$ 2M the year before so your growth rate is 50 %. This could allow you to negotiate a multiple of possibly 12 therefore your inauguration is valued at \$ 3M x 12 = \$ 36M. Selling 50 % of this inauguration and receiving \$ 18M from an investor would decidedly be life sentence changing. 🙂
There can besides be many variations to valuation since some companies may want to value the company on gross for the stopping point 12 months, or projected tax income for the forward 12 months or even a mix ( 6 trailing months and 6 project months ). Lots of options and complexity .
evaluation is a reasonably complex subject and I am giving it a very casual overview. There are companies who will charge you thousands of dollars to analyze your business to produce a report on the prize of the business. For some transactions, this may be necessary particularly if you need to substantiate valuation for tax purposes or other conformity reasons .

## What about pre-revenue or early revenue startups?

Calculating measure is even harder if there is no gross or if it is very early days and the inauguration doesn ’ thymine have much tax income however. In these situations, a convertible notice is frequently used. A convertible note is efficaciously a loan that converts into equity for the lender at some point in the future. It allows valuation to be put off until a Series A round of finance occurs which will be an easier time to determine valuation. convertible notes are elementary, faster and typically cheaper ( in terms of legal fees ) than an fairness buy for early stage startups. There are besides potential advantages in terms of taxes and not giving away any command in the inauguration but I won ’ metric ton excavate into this as convertible notes are a big subject all on their own. barely know that a convertible note has an interest rate and typically besides a evaluation cap and much a conversion deduction.

## Example of a convertible note

investor puts in \$ 500k and receives a convertible note with a conversion discount of 20 % ( reasonably typical ) and a valuation cap of \$ 5M and an annual interest rate of 5 %. When the Series A round happens after 1 class, let ’ s say the valuation is determined to be \$ 10M. Assuming shares are being sold at \$ 1 per plowshare in the Series A round, the investor would buy their shares at 0.50 per share due to the evaluation detonator so they would receive 1 million shares. The conversion rebate wouldn ’ deoxythymidine monophosphate use since the valuation cap yields a lower plowshare price than the discount. The investor would besides receive extra shares based on 5 % interest for 1 class on \$ 500k ( 25,000 shares ). The early on investor is rewarded with 1,025,000 shares for their \$ 500k early on investment whereas the Series A investor lone receives 500,000 shares for \$ 500k .

## SAFE (simple agreement for future equity)

A popular option to convertible notes in late years is the SAFE agreement which was created by Y Combinator ( you can download a template on-line ). They are very like to convertible notes but they are not a lend and do not accrue sake. They are bare and easier to implement than a convertible note .
hopefully this has given you a basic sympathize of evaluation so you know some of the terms and where to start digging further. good luck !

besides remember that the most attractive thing to an investor will be gross and increase – so build a great startup that is growing and you won ’ metric ton have trouble finding investors .