Startup valuation – that defines the value of tangible and intangible assets of a startup – reached dizzying heights amid a funding frenzy during the pandemic. However, investors believe the onset of funding winter this year served as a cleansing period, bringing valuations down to more realistic estimates.
Valuations have come into the limelight with rapid growth of tech startups, thanks to funding trends and rising M&A deals in the ecosystem. According to industry data, last year was stellar for the Indian startup ecosystem with 46 new entrants to the coveted unicorn club in 2021 alone. However, amid the funding winter and cleansing period, reports reveal that over 20 unicorns have been added this year.
Amid the unprecedented economic conditions, the startup ecosystem witnessed volatile valuations, ballooning and shrinking based on funding trends.
So how can angel investors have a consistent way to evaluate startup valuation?
Here are the top five factors to consider when deciding for a fair valuation.
Know the Target Addressable Market (TAM)
Total Addressable Market (TAM) shows the total possible market for any business. While a single company is not likely to have 100 percent of the market share, knowing the TAM is a good way for investors to understand how large the business can scale and generate revenue. In short, it is a snapshot of the entire market’s potential. So shorter the total addressable market, lesser the scope of growth and bigger the TAM, larger the size and scope for growth.
For example, the total addressable market for India’s direct-to-consumer (D2C) brands was valued at $ 33.1 billion in 2020. The sector is expected to reach $100 billion by 2025, indicating promising growth opportunities for D2C brands.
Understand market dynamics and regulations
It is also important for investors to understand the nature of the market, the strength of its competitors, and regulations that may impact a startup’s performance now or in the future. While some investors believe the existence of competitors validates market opportunities, a startup should show its strength and potential in growing into an influential or dominant player.
At the same time, investors are usually wary of volatile sectors such as crypto-based businesses as they are heavily bound by regulations. After a long period of concern and caution towards crypto businesses, India has gotten close to banning the cryptocurrency altogether to now levying 30 percent tax on returns made from cryptocurrency trading.
Founding team and their experience matters
The strengths and weaknesses of a founding team can make or break a startup in its early stages – and angel investors bet heavily on the founding team. Naturally, founders and their team with greater knowledge, expertise, and experience in the field can further boost their business and eventually qualify for higher valuations.
Know the valuation multiples technique
Valuation multiple is a financial tool to measure financial metrics of a company. It essentially takes one financial metric as a ratio and makes one business more comparable to others to get an accurate value. This method helps ascertain the business value of a startup and fair value of another company. It also helps showcase the relation between current valuation and historical periods.
Take previous funding rounds into account
Startups may often come with tall valuation claims in order to protect its equity. In such cases, taking previous funding rounds into account helps set the benchmark to measure a company’s value for your investment.
(To learn more about angel investing, explore Learn by LetsVenture, a destination portal for lessons across stages of angel investing and free resources)
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