Valuation of a late stage company is a fairly straightforward process with many quantifiable metrics available that translate to the overall value of the business. Early stage companies are trickier. Commonly an early stage company does not have revenue or even a repeatable business model, however this does not translate to not having value.
Early stage company valuation is different from public or later stage private company valuation. Neil J. Beaton provides an explanation of this in “Valuing Early Stage And Venture-Backed Companies:”
“Early stage company valuation is unique in the overall sphere of business valuation. Early stage companies often lack the traditional valuation metrics of cash flow, earnings, or even revenue at times. Without these metrics, traditional discounted cash flow models and comparison to public markets or private transactions take on less relevance, and a more ‘experiential’ valuation approach is called for.” (Page ix)
This experiential valuation of early stage companies make valuing these companies more of a qualitative as opposed to quantitative process. Early stage company valuation is more art than science, there are no hard and fast rules:
“When a prominent venture capital expert was asked what figures into his valuations, he answered, ‘Three guys, a garage, a product, or a beta site.” (Page 3)
Adding to the complexity, there is little consensus among accounting firms about how to go about valuing early stage businesses. This is a result of the lack of quantifiable information available at this stage of the company. Valuation experts require three items to value an asset:
1. An income stream
2. A discount rate
3. A growth rate
With an early stage company, two of the three preceding items are usually missing. If an income is even present in an early stage company, the evaluation is generally informal when compared to their later stage counterparts:
“First the income stream is sometimes little more than an “Excel exercise” based on a spreadsheet model that is typically built on numerous untested assumptions. Second, the growth of the income stream is a pure SWAG (i.e., scientific wild-ass guess). The importance of the discount rate diminishes – without a relevant and reliable income stream or growth rate, what is there to discount?” (Page 4)
The preceding outlines the challenges with valuing an early stage entity. Valuation of an early stage company requires the use of a more experiential method (different metrics) as well as be targeted to the correct individual or entity such as a venture capitalist as opposed to a common stock investor.
The following are resources for early stage company valuation:
1. American Institute of Certified Public Accountants (AICPA). Valuation of Privately-Held Company Equity Securities Issued As Compensation:
2. Neil J. Beaton. Valuing Early Stage And Venture-Backed Companies: