Start-up Valuations

In February 2018, Ant Financial invested $200 Mn in Zomato, an online restaurant discovery and food delivery platform, with a pre-money valuation of $945 Mn, achieving the “Unicorn” status, nearly 14 times its turnover despite a loss of $12 Mn as of March 2018. Zomato made a loss of Rs. 44 per delivery. Ant Financial further invested $210 Mn in October 2018, valuing the company at $1.8 Bn on a pre-money basis.

In March 2019, German food tech major Delivery Hero led a group investment of about Rs. 441 crore ($62.5 Mn) in Zomato, valuing it at more than Rs. 15,000 crore ($2.2 Bn) pre-money. Within a year, Zomato’s valuation had doubled.

However, Zomato was still not profitable, with a turnover of $206 Mn and a loss of $294 Mn (~Rs. 2000 Cr). So, what makes investors willing to invest in Zomato? The answer is growth.

Zomato tripled its turnover in 2019 ($68 Mn → $206 Mn). If growth continues at 100% YOY, turnover could reach $1.65 Bn by year three; even a 50% growth rate would lead to $700 Mn. Zomato operates in over 10,000 cities globally, in 24 countries, with 1.4 Mn active restaurants and 70 Mn active users. Every month, 5 Mn new users register and 11 Mn app installations occur.

In India, Zomato serves 250 million users across 300 cities. In August 2018, Hyperpure was launched to supply fresh ingredients to restaurants, recognized by a ‘Hyperpure Inside’ tag. In September 2018, Zomato acquired Tonguestun, aggregating caterers for office cafeterias.

But sustaining growth is a challenge due to discounts and competition from Swiggy and Uber Eats. Zomato illustrates the key challenges in startup valuation: high growth potential, limited financial history, negative or small financial indicators, and high risk of failure. Traditional valuation methods often struggle with such companies.

Factors Affecting Start-up Valuation

Entrepreneurs are often optimistic, which can lead to high valuations and make fundraising difficult. Value unlocking is iterative. Key factors for startup valuation include:

• Market Size: Innovative ideas often target unknown markets. Estimating demand and supply is critical.
• Team: Investors bet on strong, talented, innovative, and goal-oriented teams capable of executing ideas.
• Traction: Shows business adoption via users, revenue, or customers. Metrics vary by industry (e.g., app installs or subscribers).
• Stage of Company: Whether in ideation, prototype, or operational stage. Investors prefer market-accepted startups to reduce risk.
• Comparable Companies: Analyzing similar startups’ valuations helps estimate price.

Limitations of Traditional Valuation Methods

Traditional methods may not fully capture startup potential:

1. Discounted Cash Flow (DCF) Method

• Business Forecast: DCF relies on accurate forecasts, which are hard for startups without historical data.
• Terminal Value: Often represents 90–100% of value, difficult to estimate for startups.
• Discount Rate: Calculated using comparable companies, which may not exist.
• Asset Generation: Startups have few existing assets; most value comes from expected growth assets.

2. Comparable Multiple Method

• Comparable Company: True comparables with similar growth, risk, and structure may not exist.
• Negative Bottom-line: Multiples like P/E or EBITDA are less meaningful with losses.
• Funding Comparisons: Terms of other startups’ funding may not be fully known.

3. Net Assets Method

• Asset-light startups may not own significant assets; e.g., Facebook paid $19.6 Bn for WhatsApp (55 employees, minimal assets).

Startup Valuation Methods

1. Venture Capital Method

• Pre-money Valuation: Value before investment.
• Post-money Valuation: Pre-money + Investment.
• Process:

1. 1. Estimate terminal value in harvest year.

   2. Back-calculate pre-money valuation using desired ROI and investment.

Example:
Investment: INR 100 Lakhs, 5-year horizon, expected 5th-year profit INR 200 Lakhs, PE multiple 12, desired ROI 20%.

• 5th-year valuation: 200 × 12 = 2400 Lakhs
• Required future value: 100 × (1.20)^5 = 250 Lakhs
• VC stake: 250 ÷ 2400 = 10.41%

2. Berkus Method

• Designed by Dave Berkus, for tech and other startups.
• Assigns value to five success factors (Sound Idea, Prototype, Management, Strategic Relationships, Sales).
• Max value: $2.5 Mn

3. Scorecard Method (Bill Payne Method)

• Compares target startup with funded peers.
• Evaluates 7 critical factors with weights:

  Factor	Weight
  Management Team	30%
  Size of Opportunity	25%
  Products & Technology	15%
  Competitive Environment	10%
  Marketing & Sales Channels	10%
  Additional Funding	5%
  Other	5%

• Weighted rating × average pre-money valuation of peers = target valuation.

4. Risk Factor Summation Method

• Based on Scorecard Method’s pre-money valuation.
• Rates 12 factors (-2 to +2); 1 rating = $250,000.
• Sum of factor adjustments + base valuation = final valuation.

12 Risk Factors: Management, Stage, Legislation, Manufacturing, Sales & Marketing, Funding, Competition, Technology, Litigation, International, Reputation, Exit Potential.

5. First Chicago Method

• Considers three scenarios: Best Case, Base Case, Worst Case.
• Assigns probabilities and calculates weighted average using Venture Capital or DCF methods.

Closing the Valuation Gap

Reasons for gap:

1. Over-optimistic entrepreneur valuations

2. Different valuation methods chosen by entrepreneurs vs. investors

3. Entrepreneur expectation vs. investor expectation

Solutions: Professional advice from a Registered Valuer

Other Startup Valuation Strategies

• Shares with Differential Voting Rights: Raise capital without losing control.
• Staged Closings: Fund in tranches based on milestones.
• Warrants: Protect investor downside via call options.
• Deferred Valuation: Fix valuation for next funding round.
• Valuation Collars: Set min/max valuation to protect both parties.
• Liquidation Preference Shares: Preference shares protect investor rights during liquidation.

Conclusion

Startup valuation in India requires a mix of traditional and startup-focused methods. Entrepreneurs should focus on growth potential, market size, team quality, and traction while understanding investor perspectives to bridge the valuation gap effectively.