Bringing Up Baby: Make Sure Your Valuator Understands Upstarts

In spite of the sagging economy in parts of the United States, many ambitious entrepreneurs are still in the business of starting up new companies. The trick is: How do these entrepreneurs value their upstarts? Companies that have been in business a long time have years of data behind them to help establish a sound valuation. But it quite a different story when it comes to newer ventures. Here why.

Looking Forward

Regardless of the type of company that involved, valuation is all about looking to the future. A company value is based on its ability to produce economic benefits, in the form of cash flow, profits or other returns, for its owners and investors. That why fair market value is commonly defined as the amount at which property would change hands between a willing buyer and a willing seller, when neither party is under any compulsion to buy or sell, and both parties have reasonable knowledge of the relevant facts.

Having a history of revenues and profits enables a valuator or potential investor to predict future financial performance with greater confidence. On the other hand, a startup lack of a track record doesn't mean it has no value. It does mean, however, that potential buyers or investors will likely view the prospects for achieving projected earnings as presenting greater risk. So, to compensate for that risk, a buyer or investor would demand a greater rate of return, which then translates into a lower value. Given the fact that a high percentage of startups fail in their first year, it important to assess risk closely.

Gauging The Level Of Risk

Valuators look at a number of factors to estimate a startup future performance and to gauge the level of risk involved. Among them is the quality of the company management team. Management skill, experience and performance record with similar businesses is one of the most important predictors of future success.

In addition, the business plan and financial projections or forecasts are critical factors. Although the valuator may need to discount internal projections or forecasts to reflect management natural optimism, no one knows the company products and services better than the business founders and senior executives. The valuator will ultimately use management projections, assuming that they're realistic and based on reasonable assumptions.

Appraisers also look at the experience and value of comparable companies, industry and market statistics, and the value of intellectual property or other assets that may give the company a competitive advantage.

The Bottom Line

Valuing an upstart company can be a difficult task. But if you work with a seasoned valuator, he or she can help you through the process at every stage, helping to ensure a client baby grows up and flourishes over time.