How can founders set realistic goals for business valuation?

Misvaluing one’s own business can lead to costly mistakes such as Yahoo’s shareholders having to settle for nearly 1/10th of the payout that was once offered. Not only that, inaccurate valuations stemming from inaccurate growth projections can snowball into ill-timed expansions that must be compensated with painful layoffs, loss of investor trust, and even dissolutions.

We saw something similar happen with Quibi which was burdened with extreme growth expansions as it secured a $1.8 billion valuation before even launching.

Hence, in this article, we will explore the importance of accurate valuation goals and also try to form a process for setting smart goals for startup valuations. Read on to know more!

Importance of setting accurate valuation goals

Accurate valuation goals are not just safeguards against excess dilution. Your valuation goals are a reflection of the growth you can foresee your startup achieving. When you set achievable valuation goals for your business, you can better estimate the capital and resources needed to drive expansion.

Let us examine some valuation-related strategic missteps made by startups to deepen our understanding of the importance of accurate valuation goals.

Uber’s failed IPO triggers layoffs and market exits

After reaching a $76 billion valuation in a $500 million funding round in 2018, Uber was galloping towards a stellar initial public offering (IPO) in the following year. Bankers had valued the ride-hailing company at $120 billion and the upper price range of the IPO appeared to have enticingly valued the company at close to $90 billion, a 25% discount. However, Uber managed to secure a valuation of only $82.4 billion in its IPO!

Furthermore, when Uber’s share price dropped 7.6% on listing day, it marked the largest listing day loss by value in US history. By the end of 2019, Uber’s share price was 33.91% lower than its IPO price.

This bloodbath was followed by drastic measures. 2 months after its IPO, Uber laid off 400 employees from its marketing team in its efforts to streamline operations. In the following year, as the pandemic disrupted businesses worldwide, the company laid off another 6,700 employees. Thus, a total of nearly 7,100 employees were laid off within 13 months of Uber’s listing.

In this period, Uber announced that it would exit the food delivery business in seven countries.In hindsight, we can argue that over-optimism regarding Uber’s valuation led its founders to overexpand and later, make painful cuts, causing agony for investors along the way.

Yahoo! waves by a lucrative acquisition

Back in 2008, Google was already dominating the search engine and online advertising market, leaving Yahoo! and Bing in the dust. At the time, Google held a 63.5% share of the US search engine market.

In response, Microsoft proposed an acquisition of Yahoo! to create a more competitive choice for internet users. This $44.6 billion acquisition offer valued Yahoo! at a 62% premium to its last closing price. However, Yahoo! declined this acquisition offer stating that the offer had significantly undervalued it!

Microsoft was forced to withdraw its bid even after hiking its bid by roughly $5 billion!

Roughly eight years down the line, Yahoo! was valued at $33.4 billion and to add insult to injury, around this time, Yahoo! was acquired for $4.8 billion by Verizon. The most unfortunate $5 billion deal in history could have been avoided with an accurate valuation projection.

How do you set realistic valuation goals?

Setting achievable business goals will come naturally once you answer the following questions.

Which valuation methodology is right for your company?

Using the wrong valuation methodology is like wearing the wrong prescription glasses, both are bound to distort your vision. Valuation methodologies can be broadly divided into asset-based, market-based, and income-based approaches, and each approach applies to different sectors and business models.

For instance, if we valued Stratus Properties, a real estate firm, by the asset-based method we would arrive at a valuation of $191 million while its market capitalization is about $204 million.However, if we valued WM Technology, a tech firm, by the asset-based method, we would arrive at a valuation of $16 million while its market capitalization is about $230 million.

The following table shows when each valuation approach is applicable.

 

Valuation approach	When is it applicable?
Asset-based	Asset-heavy business model Liquidation
Income-based	Startups that are already generating revenue
Market-based	Similar companies were involved in funding rounds, mergers, or acquisitions

Another important thing to note is that you must apply an appropriate discount for lack of marketability when you value your startup.

Which metric is most closely tied to your company’s valuation?

While Netflix and Google are both tech companies, valuing them both by monthly search volume is not appropriate. This metric applies better to Google, a search engine for which search volume directly relates to advertising revenue. In contrast, monthly user engagement in hours is a better fit for valuing Netflix, the over-the-top (OTT) streaming platform.

As a founder, there must be a metric, your North star, that you always keep an eye on. For a software-as-a-service (SaaS) company, this metric would be your average revenue per user (ARPU). For a social media platform like Meta, the key metric would be its monthly active users (MAU).

When you are creating a valuation multiple, you must base it on your North Star metric. This will provide you with an accurate estimation of how the current market should value your startup.

What is your position in the market hierarchy?

In every market, there is a hierarchy of highly-valued market leaders followed by challengers with lower valuations. However, some companies manage to carve out niches for themselves and their valuations do not follow the typical market share-valuation trend. It is crucial that you identify where your startup fits within this hierarchy.

Then, you must estimate how long it would take for you to expand your niche. Achieving a similar market share to a competitor could align your valuation more closely with theirs. This exercise should help you estimate timelines for your valuation growth. This approach prevents the common startup mistake of assuming that past growth rates will automatically continue indefinitely.

After all, the jump from rank 100 to rank 10 may occur in months, but becoming the undisputed number in your market may require years or even decades. In markets like carbonated soda, even after decades of competition, there is no clear winner among Pepsi and Coca-Cola.

How do external factors affect your company’s valuation?

In 2021, as the COVID-19 pandemic necessitated lockdowns and limited physical retail purchases, Instacart, the grocery delivery platform, was able to secure funding at a valuation of $39 billion. However, the company’s 2023 IPO valued it at $9.9 billion. In the space of 2 years, the company’s valuation fell by 74.62%.

The period from 2019 to 2023 has many such prime examples of belief perseverance or confirmation bias. Before the pandemic really set in, there was a general consensus about our ability to contain infections and tackle the spread of viral diseases. As the lockdowns persisted, we saw them as a permanent reality rather than a phase. During this time, valuations of many businesses like Netflix, Upwork, and Zoom experienced significant fluctuations, with sharp peaks and troughs, because we failed to predict how long pandemic conditions would last.

Hence, to accurately evaluate startup growth, you must develop the foresight to visualize how different market conditions would affect your startup’s valuation. You should also try to incorporate expert outlooks into your valuation goals.

Eqvista – Precise valuations to drive smarter growth decisions!

Accurately evaluating startup worth enables founders to effectively protect themselves from dilution in funding rounds and seek a fair price in acquisitions. Setting achievable valuation goals, enables founders to make informed decisions and align their workforce with the company’s long-term vision.

To actually set accurate valuation goals, you must first understand which valuation methodology is appropriate and which metric is most closely tied to your company’s valuation. Then, you must strategize how your startup would climb up the hierarchy of its market. While setting valuation goals, you must also contemplate how external factors affect your company’s valuation.

If you lack familiarity with business valuation strategies or seek an objective third-party perspective, Eqvista’s detailed valuation reports provide a solid foundation for building your growth strategy. Contact us to know more!