Most Founders have NO IDEA about this method by which VCs value their startups!
The VC Method of valuation was developed in 1987 by a Harvard Business School Professor.
In this case, the VC first estimates an exit valuation and then works backward to think how can he make a 20X return on exit by fixing a value to the business today.
Let’s look at it through a simple example.
Target Exit Valuation = 100 Crore
Return wanted on Exit = 20X
Thus, Ideal Post Money Valuation today = 100/20 = 5 Crore
Amount being Invested in the Startup = 1 Crore
Pre-Money Valuation = 5-1 = 4 Crore
Now, assuming the investor’s shares will be diluted by 50%
So Pre-Money Valuation adjusted for future dilution = 4/2 = 2 Crore
The next natural question that comes up is how do they determine the Target Exit Value of the business after 8 years.
This they do by looking at by estimating say in the 8th year from now, the company will have revenues of 80 Crore, on which say the Profit will be 10% at 8 Crore.
In the 8th year, it is expected the PE Multiple for companies in the same sector to be 15. This means, company’s value will be 15 times its profit. Then 15 x 8 = 120 Crores target exit valuation.
I recommend startups use multiple methods before going ahead and pitching to an investor so that their valuation ask is validated through all possible valuation models.
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A Chartered Accountant with about 10 years of experience in areas of Tax Advisory, Startup Consulting, Fundraising, Audits, Deal Advisory, Business Modelling and contract CFO services.
Winner of the ISB Young Leader Award 2017 and the Best All Rounder, PGP Class of ’17, Sarthak has also been published about in the leading financial newspapers such as The Financial Express as possibly the youngest Indian to have completed the courses of CA, CS and CMA along with a graduate degree in Financial & Investment Analysis from University of Delhi, all by the age of 23 years.
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