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THE CHARTERED ACCOUNTANT

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Valuation of Startups: What we’re

doing and what we should be doing
CA. Vikash Goel
Member of the Institute
The valuation of startup companies should ideally be no
different than the valuation of any other company. However,
their lack of history, lack of comparable, uncertain future
makes their valuation a complicated exercise. In many
cases, startups are “priced” rather than “valued” by the
investors. Valuers should consider important factors while
using the DCF method of valuation. More importantly,
valuers should increasingly use Cost Approach for valuing
pre-revenue startups and consider Scorecards to assess
various parameters suitable for the valuation of startups.

S
tartups have emerged as
powerful engines of wealth
creation, innovation, and
mass impact in today’s dynamic
business landscape. Driven by a
spirit of creativity and risk-taking,
startups have the potential to
disrupt industries and reshape
economies.
India’s startup environment
is vibrant and dynamic,
characterized by rapid growth
and innovation. As one of the
world’s fastest-growing startup
ecosystems, India has witnessed
significant growth in the number
of startups. They have created
huge impact across various
sectors, including technology,
e-commerce, fintech, health
tech, edtech, agritech, and
renewable energy.
However, valuing startups poses
unique challenges due to their
rapid growth, evolving nature,
and high-risk environment.
Defining Startups: While there
is an ongoing effort among G20
members to establish a common
definition of a startup, we will
continue to refer to startups
that are young, innovative, and
growth-oriented companies.
In India, an entity is required to
fulfil the following criteria to be
recognised as a Startup and avail
tax benefits under DPIIT.
� The Startup should be
incorporated as a private
limited company or registered
as a partnership firm or a
limited liability partnership
� Turnover should be less than
INR 100 Crores in any of the
previous financial years
� An entity shall be considered
as a startup up to 10
years from the date of its
incorporation
� The Startup should be
working towards innovation/
improvement of existing
products, services and
processes and should have
the potential to generate
employment/ create wealth.
An entity formed by splitting
up or reconstruction of an
existing business shall not be
considered a “Startup”.
All Startups are private
companies, but all private
companies are not Startups.
Evaluating Startups for
valuation
Just like any other business,
evaluating startups require a
good understanding of business
model. Since there is limited
history, the key challenges for the
valuers is that they must make
assumptions about the future
of the business based on the
management narrative and their
own judgement.
As one of the world's
fastest-growing
startup ecosystems, India
has witnessed significant
growth in the
number of startups.

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Life Cycle Stage (from
Pre-Revenue companies to
Free Cash Flow generating
companies): A companies’ age
in and maturity is an important
factor in business valuation. A
company which is in ideation
stage and does not have a
ready product may not be
assigned great value. There
is nothing on the ground and
the idea may never take off.
Plus, there is no copyright or
patents available on an idea.
So, valuers should avoid placing
premiums on companies based
on PowerPoint presentations
and Founders’ selling skills.
The valuations may go up as
the company scales in terms of
developing a product, hitting the
markets (generating revenues),
confirming the Product-Market-
Fit (PMF), generating operating
profits, pivoting to navigate
through competition, scaling
through operating milestones,
and generating positive free
cash flows.
Competition: Startups often
face barriers to entry, such
as regulatory hurdles and
high capital requirements.
May not survive in the
long run
Apply probability of
Future of the company
Will survive amidst
competition and scale
Will scale on its own
Apply perpetual growth
rate in terminal value
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Overcoming these barriers
is crucial for long-term
success. Additionally, startups
must establish sustainable
differentiation by offering unique
value propositions, disruptive
technologies, or innovative
business models to stand out
in crowded markets. A startup
may have innovated a process
or product, but valuers must
be careful before assigning it a
premium. In this age of rapidly
evolving technology, it’s easier
for competition to catch up
quickly. Operating in a crowded
market increases the risk of
market erosion, as intense
competition can lead to price
wars, reduced profit margins,
and challenges in acquiring and
retaining customers. Valuers must
understand the Total Addressable
Market (TAM), including its size,
growth rate, and market trends,
for estimating a startup’s growth
potential and overall valuation.
Valuers should be cautious when
founders claim about how their
business is unique and will beat
competition. They must exercise
their own judgement and
experience.
default
Will be acquired by
competition
Apply Exit multiple in
terminal value
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Business Model: Apart from
competition, the scalability,
and ability to consistently meet
market demand are vital factors
in assessing a startup’s potential
for growth. A recurring revenue
model, shorter sales cycle, and
compelling value proposition
contribute to a startup’s
valuation. Demonstrating
consistent growth, customer
engagement, and retention are
strong indicators of a startup’s
potential value. Valuers should
also assess if the business is
solving a real problem or is a
discretionary spend. While there
is market for both and both can
drive value, they have unique
consequences in future viability.
During its journey to become
the giant that Flipkart is today, it
pioneered the concept of Cash
on Delivery (COD). It overcame
the hurdle of low credit card
usage in India and accelerated
the adoption of online shopping.
The company’s customer-centric
approach ensured that discounts
were focused on benefiting
customers, while its constant
experimentation and innovation
allowed it to stay ahead of
market trends. Flipkart’s efficient
logistics strategies, adaptable
commission policies, and
recognition of high-performing
sellers further solidified its
position as a transformative
force in the Indian e-commerce
market.
Founders and Team:
Evaluating the team’s
experience, expertise, potential,
technological capabilities, and
co-founder dynamics is crucial
for assessing a startup’s long-
term viability. However, just
because the founder was a
CEO of a large tech company
doesn’t mean he can be a good
entrepreneur. Having a strong
board of advisors may be
helpful but will not drive strong
premiums. Advisors usually
don’t have their skin in the game
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The ability to
generate incremental
revenues, and positive
contribution are key
considerations while
valuing startups.
and often are the first ones to
jump ship when businesses
go south. For a Tech-based
company, a non-tech founder
may have built a tech product
through outsourcing. The
tech vendors may replicate
the product for others or may
not provide services beyond
a point. In the absence of a
tech team and a tech founder,
the technology risk increases.
Valuers should consider such
factors in valuation.
Financials: The ability to
generate incremental revenues,
and positive contribution
are key considerations while
valuing startups. Evaluating the
startup’s potential to sustain
cash flows and high margins
is also crucial. Specific factors
such as burn rate, use of funds,
previous funding rounds, past
valuations, and dilution also play
a significant role in determining a
startup’s worth.
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1. Employee Stock Ownership
Plans (ESOPs) and
Convertibles: Startups
frequently use ESOPs and
convertible instruments for
fundraising and incentivizing
employees. These complex
financial instruments require
careful consideration in
valuation to account for
their potential impact on
the company’s value. While
assessing the value of
convertibles (e.g. Warrants,
Optionally Convertible
Preference Shares,
Compulsorily Convertible
Preference Shares, Optionally
Convertible Debentures or
Compulsorily convertible
Debentures), valuers
must assess the terms of
conversion carefully, apply
option pricing techniques
(where applicable) and assess
the value. Also, while arriving
at the value per share, valuers
must assess the impact of
dilution of such convertibles.
The startup may command a
high valuation premium or a
discount based on the evaluation
of startups as shown below.
Methods of Valuation
Market Approach:
Market approach relies on market
values of the subject asset or of
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comparable companies. Finding
comparable companies for
benchmarking purposes can be
challenging for startups. Startups
operate in unique niches, and
even if comparable companies
exist, they may not be suitable
for direct comparison.
Comparables (Comps): This
method involves looking at the
valuations of similar startups in
the same industry and region.
It’s important to consider factors
like the stage of development,
growth potential, and market
conditions. For companies where
a recent valuation has been
done, valuers can use those as
a reference point and check for
updates or differences. While
early stage startups use Price
to Sales multiples to arrive at
comps based valuation, there
isn’t enough reliable data and
such multiples can be very
divergent. Valuers must exercise
caution while applying multiples.
Precedent Transactions: Similar
to comps, this method looks at the
valuations of startups that have
recently been acquired or gone
public. This can provide insights
into what investors are willing to
pay for similar businesses.
Income Approach
Discounted Cash Flow (DCF):
DCF involves estimating the
future cash flows the startup is
expected to generate and then
discounting them to their present
value. This method requires
making assumptions about
revenue growth, profitability, and
the discount rate.
Some of the things to note
around financials include:
1. Historical and projected
financial statements:
Startups usually have limited
financial history, making it
hard to identify meaningful
trends or apply traditional
revenue/profit multiples.
Valuers should ensure that the
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projected financial statements
(wherever provided by the
management) are reasonable.
For example, revenue
forecasts, should be backed
with robust assumptions
along with probabilities and
scenarios. The profit margins
should be reasonable and in
line with industry benchmarks.
Valuers should understand that
revenue growth may not come
without capital expenditure
and marketing spends, which
requires funds availability.
In case of profitable ventures,
where profits are ploughed
back, the working capital
assumptions and profit
margins should be reasonable.
Further, the cash flows should
factor in the uncertainties
around the business.
Startups often go through
frequent pivots, changing
their business models, target
markets, or product offerings.
This high level of uncertainty
makes reliable projections
challenging, as the future
direction of the startup may
not be clearly defined. Valuers
should ensure that the financial
projections incorporate such
scenarios or possibilities.
2. Financial statement
adjustments: Valuers may
have to make suitable
adjustment to financial
projections.
a. Research & Development:
Valuers should see if the
company has invested
heavily in technology or in
Research & Development.
While accounting
regulations require
expensing most R&D costs,
for valuation purposes,
some of these can be
treated as Intangibles.
Suitable adjustments must
be made to assess what
portion of these expenses
are expected to yield
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benefits in the long run.
Valuers should suitably
model the intangibles
leading to capitalisation
of some of the expenses
and amortising them
over a reasonable period.
Consequently, the
profitability and cash flows
would take a different
shape than the reported
financial statements.
Similar adjustments may have
to be made for discretionary
spends, promoter or key
managerial personnel (KMP)
salaries and other items that
should be recorded as per
industry benchmarks. For
example, if the company
is utilising the founders’
services, the cash flow
projections should consider
suitable expenses attributed
to the founders even if they
are not taking salaries. In
case these expenses are not
adjusted in the cash flows,
valuers should make suitable
adjustments in the discount
rates to consider such factors.
Discount Rates: While Capital
Asset Pricing Model (CAPM)
serves as a good reference
point for assessing the cost
of equity, the absence of
Beta becomes a hindrance in
applying CAPM. While many
authors and practitioners
argue in favour of using the
comparable listed companies,
the risk profile is usually
very different for startups as
compared to listed peers.
Valuers may consider an
additional risk premium
with suitable assumptions
to incorporate risk factors
applicable to startups. This
additional risk premium may
incorporate, among other
things, lack of marketability,
size discount, unreasonable
projections (where
management provided cash
flows are not fully defensible),
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business risk in pivoting to
other models and more. Such
Adjusted CAPM approach or
the Build-up Method may allow
valuers to consider the overall
riskiness of the cash flows
while applying discount rates.
While some regulations prefer
Discounted Cash flow Method
of valuation for valuing startups
as well, predicting financials of a
young startup is extremely risky
and a simple DCF may not be the
right method to value startups.
Even if applied, sensitivity
analysis or even Monte Carlo
Simulations must be considered
before arriving at a final value.
In its simplest form, valuers
must assess a probability of
default especially in case of early
stage or pre-revenue startups.
Accordingly, the valuation may
be assessed as follows:
Value = PGoing concern x DCFValue
+ (1 - PGoing concern) x
Going Concern
Liquidation Value
Risk-Adjusted Return (Venture
Capital) Method: The Venture
Capital method provides a
framework for investors to assess
the potential value and returns of
startups. By considering future
earnings, market multiples, and
the time value of money, this
method helps guide investment
decisions and negotiations
between startups and venture
capitalists. This approach
considers the risk associated with
investing in startups. Investors
often use a higher discount rate to
account for the higher level of risk
involved. This method involves
several steps to determine the
expected value of a company.
1. In the first step, the expected
future profits (PAT) or any other
value driver such as Revenue
or EBITDA in a specific year
are estimated. These value
drivers are then multiplied by
their respective multiples, such
as the Price-to-Earnings (PE)
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ratio to arrive at the Terminal
Value or the Exit Value.
2. The estimated value is then
discounted back at the target
rate of return to arrive at the
present value of the company
as per the Venture Capitalist.
3. The next step involves
calculation of Post Money
Value and VC Stake. By
calculating the post-money
value and the venture capital
stake, investors can determine
their expected returns and the
percentage of ownership they
will hold in the company.
Example: A young EdTech
company Om Ltd is expected
to go public in 10 years. The
projected net profits of the
company at that time are
estimated to be INR 95 crores.
The average PE multiple
of publicly traded EdTech
companies is 20. Investors are
seeking a 45 percent return
on their investment until the
company goes public.
Using the Venture Capital
method, we can calculate the
exit value by multiplying the
projected net profits (95) by
the average PE multiple (20),
resulting in an exit value of INR
1900 crores. To determine the
present value of the company,
we discount this exit value over
10 years at the target rate of
return (45%). The value of the
company today is then estimated
to be INR 46.25 crores.
It is surprising that where
valuation has been arrived
at between investors and
company based on such
approach, the Valuers still end
up assessing the valuation
based on Discounted Cash
Flow Method for compliance
purposes where the projections
are unreasonable. Indeed the
regulations must be amended to
allow VC method of valuation for
startups.
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First Chicago Method: The
First Chicago Method combines
multiples-based valuation and
discounted cash flow (DCF)
valuation. It involves four key
steps: defining future scenarios
(Best, Base, Worst), estimating
divestment prices using multiples
for each scenario, determining
the required rate of return and
calculating the value under
each scenario, and assigning
probability weights to each
scenario to derive the weighted
sum. This approach provides a
comprehensive way to assess
the value of an investment
opportunity by considering
different scenarios, incorporating
market-driven risks, and
accounting for their probabilities.
Asset-Based Approach (Cost
Approach): This method involves
valuing the startup based on its
tangible and intangible assets,
such as patents, technology,
equipment, and intellectual
property. Cost approach would
normally not assign a high
premium to startups. Valuers
should apply cost approach in
cases where the startup has not
demonstrated a Product Market
Fit (PMF) and does not generate
meaningful revenues.
Berkus Method or Scorecard
Method: This method assesses
startups based on five key
criteria: the soundness of
the idea, the quality of the
management team, a prototype
or product in development,
strategic relationships, and
the potential for a viable exit
strategy. Each of these criteria is
assigned a value, and the total
value is used to estimate the
startup’s worth. Berkus method
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itself is seldom applicable to
startups in the Indian context.
It has a tendency to overvalue
entities, which should be taken
into consideration when using
this approach. However, scoring
the startup on various factors
may provide a rich input and
may be a valuable tool for the
valuers to arrive at a defensible
valuation when applied with
other methods of valuation (e.g.,
comps or Discounted Cash Flow
method). Valuers should also
consider segregating the startups
into various stages (e.g., idea
stage, prototype stage, revenue-
generating stage). The valuation
may increase as the startup
progresses through these stages.
Conclusion
In a nutshell, it becomes
challenging to value startups due
to their rapid growth, evolving
nature, and high-risk environment.
They differ from mature
companies in terms of agility
and limited resources. Valuation
methods like Venture Capital,
First Chicago, Berkus, and DCF
provide frameworks for estimating
startup value. Factors such as
competition, TAM, scalability,
team expertise, and financial
indicators are crucial. Challenges
include limited financial history,
unique accounting treatments,
complex instruments, and
uncertainty. Understanding these
methods and challenges enables
informed decisions to harness the
innovation and growth potential of
startups.

Author may be reached at
eboard@icai.in
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