Academic journal article Business: Theory and Practice

Valuing Start-Ups - Selected Approaches and Their Modification Based on External Factors

Academic journal article Business: Theory and Practice

Valuing Start-Ups - Selected Approaches and Their Modification Based on External Factors

Article excerpt

Abstract

The recent methods of start-up valuation seek to compensate for the lack of data necessary for a standard company valuation with additional information on the person of the entrepreneur and business project. None of the existing approaches, however, takes into consideration information about the environment in which the venture capitalists conduct their investments. Therefore, the aim of this paper is to develop an approach considering factors of the investee companies' environment. Such a modification will allow a more accurate estimate of the value of the projects investigated. The nature of this study is explorative. It relies on secondary data that was collected using interviews and semi-structured questionnaires in previous empirical studies. During the course of the modelling process, information on the quality of the investee companies' environment expressed is incorporated into the established start-up project valuations. Our original proposal consists of the modification of the [beta] coefficient calculation for a given type of projects. An essential part of this modification is also a proposal for the extension of the project scoring characteristics to include expert estimates and, in the case of regression analysis, the inclusion of explanatory variables expressing the suitability of the environment for venture capital investments.

Keywords

venture capital business angels start-ups valuation model beta coefficient external determinants macroeconomic determinants

JEL Classification

G11, G23, G24

Introduction

The use of conventional valuation methods for business projects at an early stage of development (start-ups), which are often the target of venture capital and business angel activities, is rife with difficulties; at the same time, however, valuation is of utmost importance if a start-up is looking to raise money for its further development. Valuation methods are usually divided into three basic groups, i.e. valuation methods that rely on cash flows, comparable transactions, and analysis of assets (Kumar 2015). The difficulty of using these approaches in the valuation of start-ups lies mainly in the fact that start-ups can provide only very little information about their history (Miloud et al. 2012). This may be due to a lack of accounting data (short history, i.e. the company has neither profits nor revenues), the lack of market data (there are no comparable companies or no direct competitors) or the fact that most of the company's assets are intangible.

The existing methods of start-up valuation seek to compensate for the lack of information necessary for a standard company valuation with additional information on the person of the entrepreneur and business project. None of the existing approaches, however, takes into consideration information about the environment in which the venture capitalists are to make their investments, i.e. external factors influencing entrepreneurial success are not reflected in these models.

The model, proposed in this article, presents a modification of the existing valuation models of start-ups by considering factors of the investee companies' environment. Such a modification will allow a more accurate estimate of the value of the projects investigated. The novelty of this study is to focus on the analysis of external factors that influence the valuation of investee companies in the start-up stage. No previous paper has, to our knowledge, dealt with the issue of appropriate methodologies reflecting these factors.

1. Theoretical background

New start-up firms face typically a lack of external financing. A large number of academic studies examining investment criteria and projects' valuation approaches emerged in the last two decades.

Nofsinger and Wang (2011) studied the determinants of the initial start-up financing in 27 countries and conclude that "institutional investors rely on the experience of entrepreneurs in managing start-ups and the quality of investor protection to reduce moral hazard". …

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