Valuation Methods to be followed by RVs for a Startup Valuation :
There are several commonly used and accepted methods for determining the fair value of the business of a company. They mainly fall under the following three categories:
A. Income based valuation approach (“Income Approach”).
B. Net Asset Value based valuation approach (“Asset Approach”); and
C. Market based valuation approach (“Market Approach”);
The application of any aforesaid methods of valuation depends on the nature of operations, level of maturity of the businesses, future business potential and purpose of valuation.
For the purpose of arriving at the fair value of the Equity shares of the Company, it would be necessary to select an appropriate basis for valuation from among the various alternatives available.
The Asset Based Valuation Method is not an appropriate method of valuing a startup business, because it does not truly measure the earning capacity of an enterprise and its growth potential.
The Market Based Valuation Method is also not an appropriate method since startups are not a listed company, they do not have a market price readily available for Valuing the Company. The Startups cannot be compared with listed comparables as well.
The Discounted Cash Flow (DCF) method under income approach is commonly used.
It is accepted as an appropriate method by business appraisers. This approach constitutes estimation of the business value by calculating the present value of all the future cash flows which the company is expected to generate.
Mathematically it can be expressed as the following formula: PV = ΣFV / (1 + i)^n
Where, PV = Present Value, FV = Future Value, i = discount rate reflecting the risks of the estimated future value, n = raised to the nth power, where n is the number of compounding periods.
Discounted Cash Flow Method values the equity on the basis of its future cash ﬂows and it has two components as follows:
(i) Discounted value of Free Cash Flows of the company for the Explicit Forecast Period and
(ii) Terminal Value (value after the explicit forecast period).