Understanding Startup Valuations and How to Calculate them in the Early Business Stage

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You may have heard the term startup Unicorn, which is a term for startups with a valuation of above US $ 1 billion. But the question is, what exactly is the meaning of startup valuation? How to calculate it?

Definition of startup valuation

Valuation is the economic value of a business. If there is a company that has a valuation of Rp1 trillion, then anyone who wants to fully acquire the company must prepare a minimum of Rp1 trillion. This valuation figure is usually used as a reference to measure how much a company’s business potential is.

As a startup founder, you need to calculate valuations to determine the percentage of shares that will be given to investors when funding occurs. This valuation is also important to determine the selling price of your startup in the event of a merger or if there are other companies interested in acquiring your startup.

Startup valuation versus conventional business

The startup valuation calculation method is actually similar to conventional business. However, because startups in the initial stages usually don’t get any revenue or profit (which is usually the basis of valuation calculations), there needs to be a slight adjustment.

To calculate the valuation of a conventional company, the following things are usually taken into consideration:

• Company value on the stock market (market cap).

• Value of other types of shares owned by the company (e.g. preferred shares, minority interest).

• Company debt.

• Company cash.

From these variables, company valuation can be obtained by the formula:

Valuation = (Stock Value + Debt) – Cash

Then what about startups that don’t yet have income and profits? Typically, the founder or potential investor will consider things like the following:

• Transaction amount and amount.

• Number of users.

• Product technology.

• Team quality.

• Competitors.

Differences in the terms of Pre-Money and Post-Money valuations

In the calculation of startup valuations there are two important terms that you must understand, namely Pre-Money and Post-Money valuations. Simply put, the Pre-Money valuation is the “price” of a startup before getting an investment, and the Post-Money valuation is the “price” of a startup after the investment occurs.

The following is a simple example to understand the difference between Pre-Money and Post Money valuations:

Then what if a startup already has several investors and wants to get new funding? How do you calculate the percentage of shares?

For that, you must find the number of new shares that must be issued with the following formula:

Example calculation of stock dilution based on startup valuation

Dilution is a decrease in the percentage of share ownership of a party caused by the issuance of new shares. The following are examples of Post-Money valuation calculations and stock ownership calculations after seed funding.

For example after that, the startup gets Series A funding:

• Post-Money Valuation from the initial funding stage above becomes Pre-Money valuation for Series A funding.

• Previously only 100 shares have now increased to 117.

The following is a calculation of share ownership for the founder and each investor.

There are also various types of shares that can be given by the founder to investors, including:

• Common stock is the most common type of stock. These shareholders have voting rights in decision making and can get dividends (profits).

• Whereas the preferred stock owner will get special rights that are not owned by ordinary shareholders. The special right can be a priority to get his money back when the company goes bankrupt and must sell assets, or get priority to receive dividends. However, preferred shareholders usually do not have voting rights to determine company policy.