Why one should convert newly started small business enterprise into a start-up
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- Before pitching an Investor its necessary to understand the difference between Start-up and Small Business Enterprises.
- Why Start-up are Commanding more valuation than small enterprises.
- Globally accepted Start-up Valuation Methods.
Most of the newly started ventures struggle to get funds because on founders mind they are startup but on paper they are small business enterprises.
Start-ups commands more valuation than Small business enterprises because start-up valuation depends more on qualitative factors, thus Valuation Methodology is also different in case of start-up Valuation.
Thus before starting the business it becomes important to understand whether you are launching a startup or small business enterprises.
Start-up definition under Investor Lens
- Start-up means scalable business model, high growth potential with huge market size & having innovative product
- Small Business Enterprises are privately owned firms that have fewer employees and less annual revenue than a regular-sized business. In most cases small enterprises designed to generate revenue from Day 1 with less Investment & low risk. However in case of Small enterprises upside potential is also limited in comparison to start-up.
Start-up definition as per Ministry of Commerce
- Till up to five years from the date of incorporation.
- If its turnover does not exceed 25 crs in the preceding five financial years.
- If It is working towards innovation, development, deployment, and commercialization of new products, processes, or services driven by technology or intellectual property.
Start-up – A Smaller Version of Large cap
Startups and small businesses often begin with very different growth expectations, thus before Investing Investor also look upon investment opportunities, type of enterprises along with the key assumptions, marketplace growth rates, market size & upside potential of the business.
Startups seek Financial Investments differently than small enterprises. Investor treat start-ups as smaller version of large cap companies, thus before Pitching Investor, one should :-
- Understand category (whether Start-up or Small Enterprise).
- Understand the Business scalability & uniqueness.
- Understand the stage of funding.
- Evaluate the option (Since every option has its own advantage & disadvantage.
- Start-up Valuation majorly depends on Founder’s background, Business model, Business scalability & Competitive landscape.
- In start-up valuation past track record and financial history are not so relevant.
- Due to unique business model & insignificant revenue, finding exact comparables or projecting the financial are also a challenge.
Why Start-up are commanding more Valuation than Small Enterprises
- Due to potential market/Unique product Service.
- Projected Market Share that would be captured by the start-up due to technology & uniqueness.
Key Points for Start-up Valuation
- Market Size (Size of opportunity)
- Business Model Uniqueness (Technology)
- Target Customer & Competition
- Current stage- for e.g. commercial service officially launched or not
- Purpose of transaction (e.g. Equity financing or preferred stock financing)
- Founder background & Team Management
- Intangibles & Patent, if any
- Last round of funding, if any
- Additional Investment
- Ticked size & Time of exit
- Selection of appropriate valuation methodology
Globally accepted Valuation Methodology for Start-ups:
Venture Capitalist method
- Step I Calculated the Exit Price for the Investor based on Investor’s expected return.
- Step II Post Money Valuation at the time of Exit based on Forward Earning.
- Step III Calculate the current equity valuation.
First Chicago Method (Scenario based Valuation Method)
- Step I Build projection under three scenarios: Success, Survival & Failure
- Step II Value the start-ups by discounted cash flow, Comparable. Companies or Comparable Transaction Method
- Step III Assign probability to each scenario.
- Step I Calculate exit year earnings
- Step II Bring the exit the year earnings into Present Value
- Step III Multiply the PV of earnings with Industry Multiple & Less Impending Financing
Option Pricing Method
- Step I Calculate the Economic worth of start up
- Step II Calculate the Breakpoints based on liquidations preference
- Step III Allocate the value between Common shareholders & preferred shareholder
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Mr. Gaurav Barick is a proud alumnus of IIFT, New Delhi & an Investment Banker specialized in Valuation, Private Equity, Equity Research and M&A. Gaurav having almost 10 years of Investment Banking & Policy Making experience with top Public and Private sector organizations. For business tie-up (to become business associates) or advisory related to Fund Raising for start-up, M&A- Restructuring, Valuation, & M&A he can be contacted at [email protected] or on 91-8130141874.
For more information please write in to [email protected]
Disclaimer: The author has taken due care and caution to compile and analyse the data. The opinions expressed above are only the views of the author, and not a recommendation to buy or sell. Neither the author nor IndiaNotes.com accept any liability whatsoever arising from the use of any of the above contents.
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