Andrew Stotz – How to Value a Startup

How to Value a StartupToday I want to talk to you about how to value a startup.This story started when Dan, a podcast listener, replied to my recent weekly email with this question, “How do you value a startup, especially if there is no revenue?”How do you value a startup?To answer this question, I decided to dust off a business plan that I wrote for a client soon after the 2000 dot-com boom and bust. For those of you who were not around then, the dot-com boom saw the US Nasdaq Composite peak in early 2000, up 400% from 1995. At that time, the New York Stock Exchange Composite index was trading at a Shiller cyclically adjusted PE (CAPE) ratio of 45x (by the way, as of this writing on July 16th, 2021; we are currently at 37x a CAPE). But after the Dot Com crash by 2002, the Nasdaq Composite had fallen by 80% from its peak.You will learn how to value a startupAfter this story, you will see that you can value an idea, activity, or revenue for early-stage companies. Ideas have value if their market size is massive and there is a reasonably high probability of success. Activity has value, particularly activity related to customers. This value derives from the fact that eventually, those users can be converted into paying customers. And that’s when revenue starts rolling in. A company may lose money for years but still have massive revenue growth.You can value an early-stage startup with no revenueA good example of this is Amazon which ramped up revenue but produced losses for many years. And now we all know there was value to those revenues. So, Dan, you can value an early-stage startup with no revenue based on its idea, activity, or revenue.Let’s get into the story.I was hired to write a business plan to help my client raise capitalThis client came to me in 2004 as we were just recovering from the dot com bust. He asked me to help his team write a business plan and value their company to raise capital from angel investors and eventually from venture capital funds. He even had big dreams of someday listing his startup on the stock market.I pulled together all the information they had and started to work on forecasting revenue and building the financial model that would lead us to the value of the business. What follows are excerpts from the report I wrote for him.Our product is globalWe believe that our product is global, so our market is the world. Therefore, the first driver of value for our business is the size and growth of the global population. As of 2004, the world’s population is 6.5 billion, and we expect it will grow at about 1.2% per year for the next 10 years and then slow to 1.1% for the remainder. That means that by year 30 of our projections, the global population will be about 8.6 billion, which is our starting point for forecasting and valuing our business.Our product is free softwareOur product is a software application that runs on a desktop computer and allows users to communicate better. We are still in the testing and development phase, and as a result, have encouraged our customers to download our software for free. Since we have also started experimenting with monetizing our software, we have generated a tiny bit of revenue. We are optimists and expect explosive growth and are raising the funding we will need to finance that growth.Only internet-connected people can use our softwareOne challenge we face is that, because we will be using the power of the internet, only those people who are on the internet can use our software. Currently, 87% of the world’s population is not on the internet, but we think that this will change over the decades to come.Addressable market of 800 million people now, and we expect 6 billion in 30 yearsTo calculate our addressable market for our software, we multiply the percent of the population (currently 6.5