As we move into the last quarter of 2022, the Indian start up valuation scene appears to be as robust as ever, even as the technology sector grapples with its share of headwinds.
With as many as 18 companies acquiring unicorn status, the sun seems to be shining brightly on the Indian start up sector.
What’s more a PwC report states we could be looking at more than 50 Indian start ups to join the much-vaunted unicorn club in the year 2022.
The sweep of industries that these new start ups represents is quite extensive and includes:
- Fractal Analytics (advanced analytics)
- LEAD (edtech)
- DealShare (social commerce)
- Polygon (blockchain)
- Xpressbees (logistics)
- CredAvenue (fintech)
- Purplle (beauty)
The year 2021 saw a record-breaking 44 new start up unicorns, which compared quite favorably with the 33 that emerged from 2011 to 2020. The continued growth in 2022, on top of what was achieved in the preceding year, is actually quite creditable.
Related: 15 Indian business unicorns to learn from
How is start up valuation arrived at in India?
India has witnessed a tremendous upsurge in its internet-based businesses in the recent past, fueled by the mushrooming growth of Indian start ups in the last two years.
These tech-enabled businesses provide cutting-edge solutions to a host of problems faced by people in their everyday lives.
That being stated, start up funding is not as easy to come by as in the past. For most part, the start ups are at a fledgling stage with:
- No track record of performance
- Often ill-defined revenue streams
- Large operational expenses
- A need to obtain access to external funding
Increasingly the investors look at the time a start up will take to turn in a profit to decide whether to fund it or not.
Start up valuation in India for its part is arrived at by following these three methods:
- Venture Capitalist Method
- First Chicago Method
- Discounted Cash Flow Method
Venture Capitalist Method
The first method of start up valuation is the Venture Capitalist Method. Venture capitalists on the lookout for investing in promising start ups would look at:
- A company’s earning potential
- The time it would take to make profits
- The kind of return on investment (ROI) they themselves could receive
Importantly, they would also like to calculate the extent of the equity stake, they would get in lieu of the investment made.
First Chicago Method
This method of valuing a start up combines elements of market-oriented and basic analytical methods. It is used in the valuation of dynamic growth companies — those that show a high likelihood of being able to weather multiple challenges and opportunities.
The First Chicago Method takes three business scenarios into account — success, failure, and survival — to arrive at the probability of each case occurring. For doing that, it considers the stage the business is at, as well as other qualitative metrics to derive the weighted average value.
The first step is to estimate divestment price for each scenario using multiples. The next task is to determine required return and calculate valuation for each scenario (many VCs do this internally). The process concludes by estimating probabilities of scenarios and calculating the weighted sum.
Discounted Cash Flow Method
This method of start up valuation relies on future performance as well as the assumption that the value of earnings in the future would be intrinsically less now than in the future.
What this essentially means is that the value of future earnings will have to be discounted to the extent of their current value. That is on account of the fact that future cash flows will always come with an associated risk, as well as the fact that their monetary value will come over time.
Apart from the above, there are other valuation methods too that can be used to determine the wisdom of investing in an Indian start up.
The bottom line in the choice of a valuation method is to get as accurate a picture of the financial viability of a start up as is possible, given the fact that investing in one is always fraught with tremendous risk.
Related: Inspiring stories of 10 female entrepreneurs in India
Tips to improve the valuation of your start up
If you run a start up and seek to improve its valuation to make it attractive to potential investors, work to accomplish these goals:
A past smooth and successful exit
Your start up’s attractiveness to potential investors as well as the probability of a higher valuation can go up substantially if your business has a past smooth and successful exit to its credit.
If an investor has sold their stake in your company for profit, this proves to a future investor that it has potential.
Something like that goes a long distance in establishing the credibility of your start up.
Good milestone financing track record
A good milestone financing track record has a very positive correlation with a start up’s valuation at the time of every funding round.
Whatever may be the nature of the milestones achieved — technical, customer-related, or anything else relevant to your business — these will have a significantly positive impact on your company’s valuation.
Have a lower burn rate
Investors are quite canny in their assessment of the use of funds by a start up. They use burn rate as an indicator of good financial management (burn rate is the amount of monthly cash that a company spends before it starts generating its own income).
Smart entrepreneurs spend as little as possible during start up.
The ratio between the burn rate and growth rate achieved by a start up is something that investors do look at when thinking of providing funding to start ups. Keeping the burn rate low is, therefore, especially important.
Learn to negotiate well
Your start up’s valuation depends to a great extent on your investors’ level of interest in your company.
The higher the investor interest, the better the valuation.
It would make eminent sense to see what kind of valuations your investors offer you, so that you can negotiate the best possible deal for your start up.
Don’t accept an offer right away — ask for time to consider it before delivering your decision. Then ask trusted financial advisors to help evaluate the offer and refine it based on their advice.
Related: What is a startup incubator?
It's a great time to be a start up in India
The Indian start up valuation scene appears to be as robust as ever as 2022 comes to a close. Start up valuation in India largely is arrived at by one of three methods
- Venture Capitalist Method
- First Chicago Method
- Discounted Cash Flow Method
For start ups looking to enhance valuation, it would make sense to ensure that they have had a past smooth and successful exit, a great milestone financing track record and a low burn rate.
Don’t underestimate the ability to negotiate well.
While investors are more circumspect and cautious than they were in the early heady days of the start up boom in India, there’s still funding to be had.
As the start up ecosystem matures, both the companies involved and the investors will gain a clearer perspective on the path ahead for start up funding. This will lead to greater clarity on what it will take to find success in the tough, but exciting world of Indian start ups.
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This post should not be taken as legal or financial advice. Always consult legal, financial and other relevant professionals before undertaking a merger or acquisition.
