Why do early-stage startups have higher valuation multiples?
Assigning a valuation to early-stage startups is particularly difficult because there is little to no financial history and their products are not market-tested. Instead, these valuations are based on the early-stage startup’s potential, which can be highly speculative. As a result, they may have higher valuation multiples than better-established companies or even other startups for that matter.
In this article, we will go a little deeper to find out why it is difficult to value an early-stage company, and why they can end up with higher valuation multiples than other companies. Read on to know more!

Why is it difficult to value an early-stage company?
Valuing early-stage companies presents significant challenges due to various factors complicating traditional valuation methods. The difficulty in valuing early-stage startups can be summed up in the following three reasons.
Challenge of Assessing Value Without a Financial Footprint
Almost all valuation analysts will tell you that early-stage startups are notoriously difficult to value because they lack a substantial financial history. Any exercise that involves estimating a variable will depend on the quality of inputs. It is easier to value a company that was listed on the stock market years ago since you know how it performs in a variety of economic and industry conditions.
However, early-stage startups are 18 to 24 months old. After that, they either close the shop or scale up. So, most early-stage startups have not even lived through a single economic cycle or industry cycle.
Challenge of Valuation in a Landscape Without Comparables
If financial data is unavailable, you would naturally look at the valuations of similar companies. Unfortunately, it can be incredibly difficult to find a comparable company with early-stage startups. Every year innovative startups are coming up in all sectors.
Even early-stage startups with the same product offerings might have different geographical locations, business models, or financial conditions. Unless you know where the differences are, you cannot make adjustments for them. Suppose you were calculating an early-stage startup’s valuation based on another comparable startup’s valuation.
If there were differences in the financial structures or market opportunities because of where these two startups operate, unless you know the exact differences, you cannot make accurate adjustments.
Impact of Human Biases on Valuation Decisions
When you lack data, you need to use advanced mathematical techniques to calculate valuations. These techniques require you to make various assumptions about the economic conditions, industry conditions, and how well could a company exploit its opportunities. The valuator’s biases are very easily reflected in how they estimate future industry conditions and the company’s expected performance.
For instance, the founder is likely to be more optimistic than an investor who has yet to decide whether to invest in an early-stage startup or not.
Even macroeconomic forecasts published by institutions can be biased because of political pressures, anchoring of expectations to recent trends, and the forecaster’s attitude (optimistic or pessimistic).
These factors necessitate a careful and nuanced valuation approach, which often involves adapting traditional methods or employing alternative metrics tailored to each startup’s specific context.
Reasons for higher valuation multiples at an early stage
Some of the reasons why early-stage startups have higher valuation multiples than other companies are as follows:

Valuations not tied to earnings
The Berkus method, the scorecard method, and the risk factor summation method are some examples of valuation methods commonly used for early-stage startups. Earnings and other measures of financial performance are not considered as the main input in these methods. Here, early-stage startups are valued based on whether they meet certain criteria or not.
So, two early-stage startups with very different earnings could have the same valuation. In such a case, the startup with lower earnings will have higher valuation multiples.
Example:
Here, we will look at two early-stage startups- Editorix and Vidiomorphic. They are both developing artificial intelligence (AI) assistants for video editing. Editorix has focused more on its distribution channel and hence has strong sales.
On the other hand, Vidiomorphic invested in strategic relationships with edtech platforms that could push its product to new video editing professionals. While these are promising partnerships, they are yet to yield results.
Now let us value these companies using the Berkus method where we study five key characteristics of a startup and assign a value from $0 to $500,000. Then, we simply sum up the five scores to get the startup’s valuation.
We have valued the two companies as follows:
Particulars | Editorix | Vidiomorphic |
---|---|---|
Sound idea | $400,000 | $400,000 |
Quality management team | $400,000 | $400,000 |
Prototype | $500,000 | $500,000 |
Strategic relationships | $150,000 | $350,000 |
Product rollout or sales | $350,000 | $150,000 |
Valuation | $1,800,000 | $1,800,000 |
Most figures for the two companies are identical except for product rollout or sales, and strategic relationships. Let us see the effect this has on the valuation multiples.
Particulars | Editorix | Vidiomorphic |
---|---|---|
Revenue | $100,000 | $40,000 |
Valuation | $1,800,000 | $1,800,000 |
Valuation multiple (Valuation ÷ Revenue) | 18 | 45 |
We see that Editorix had a reasonable valuation multiple of 18x but Vidiomorphic got a valuation multiple of 45x!
Since early-stage startups focus on product development rather than sales generation, they have higher valuation multiples like in the above example.
High expected growth
Normally, you would estimate the revenue growth based on past data. Since past data is scarce, you must make an assumption. Typically, we assume a high expected growth rate of revenue for early-stage startups. This is because early-stage startups have low revenue. So, when they scale up, the percentage change in revenue will be quite high.
As a result, we end up with higher valuation multiples than normal.
Example:
Here, we will use the discounted cash flows method to value Qubitrix, an early-stage startup in the semiconductor chip sector. Luckily, we have net cash flow figures for 2 years. We will assume that the startup can survive for the next 10 years. Also, we will discount the cash flows by 6% to adjust for inflation and find the present value.
Net cash flows of Qubitrix:
Years | Net cash flow |
---|---|
2022 | $50,000 |
2023 | $75,000 |
Currently, Qubitrix’s net cash flow is growing at 50%. We will assume that this will continue to happen for 3 more years and then the annual growth in revenue will drop to 20%.
We are essentially assuming that Qubitrix will have a high growth period of 4 to 5 years and then the growth will plateau.
Once we have estimated the net cash flows for the next 10 years, we will discount the values and sum them up to get the valuation.
Years | Net cash flow | Present value |
---|---|---|
2022 | $50,000 | - |
2023 | $75,000 | - |
2024 | $112,500 | $106,132.08 |
2025 | $168,750 | $150,186.90 |
2026 | $253,125 | $212,528.63 |
2027 | $303,750 | $240,598.45 |
2028 | $364,500 | $272,375.60 |
2029 | $437,400 | $308,349.74 |
2030 | $524,880 | $349,075.18 |
2031 | $629,856 | $395,179.45 |
2032 | $755,827.20 | $447,372.96 |
2033 | $906,992.64 | $506,459.95 |
Valuation (Total) | $2,988,258.94 |
Now, let us calculate the valuation for Qubitrix.
Particulars | Amount |
---|---|
Valuation | $2,988,258.94 |
Revenue | $75,000 |
Valuation multiple (Valuation ÷ Revenue) | 39.84 |
Thus, we ended up with a valuation multiple of almost 40x. This was after assuming a growth of 50% in the initial years. Some early-stage startups could even have a 100% growth rate. So, they will have even higher valuation multiples.
Inadequate adjustment for risks
In the previous example, we discounted the future net cash flows by 6% to get the present value. We chose 6% as the discounting factor since that is close to expected returns from risk-free assets like government bonds.
However, since the cash flows of a startup are not as stable as those of risk-free assets, the future cash flows of a startup would be worth less than future cash flows from risk-free assets.
Basically, a risk-free asset that returns $10,000 in a year will be more valuable than a startup with the same expected return. So, we need to fix a higher discounting factor for startups. This is where things get tricky.
Typically, we discount the cash flows from an asset with its expected return. Risky assets attract higher returns than safe assets otherwise no one would invest in them. Since early-stage startup equity is one of the riskiest assets out there, it should attract the highest discounting factor.
The discounting factor is often anchored to expected stock market returns. If we expect 15% to 20% returns from the stock market, some may add a risk premium of 5% to private equity and expect 20% to 25% returns.
However, we may still be underestimating the risks in early-stage startups. As a result, the discounting factor of 20% to 25% may be too low and we will end up overestimating the value of early-stage startups. This could explain the higher valuation multiples of early-stage startups.
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The main difficulty in valuing early-stage startups comes from the lack of financial data. If an early-stage startup has a unique proposition, then finding comparable companies is also difficult. Because of a lack of data, we may rely on advanced mathematical techniques that require you to make several pivotal assumptions about the company’s future performance, industry trends, and economic outlook.
Often, the techniques used for valuing early-stage startups do not have earnings or revenue as the key input. Instead, qualitative factors like the soundness of the idea and the quality of strategic relationships may be considered.
Another reason for higher valuations in early-stage startups is their high growth rates. Since their revenue grows at a fast pace, the valuation is tied closer to expected future cash flows rather than existing cash flows.
Higher valuation multiples can also result from inadequate adjustments for risks.
If you are a founder of an early-stage startup or someone looking to invest in one, Eqvista can help you with accurate and research-backed valuation reports that will give you an edge in fundraising negotiations. Contact our team now and get trustworthy startup valuations!