Company valuations often make headlines - especially when businesses achieve multi-billion-pound valuations without turning a profit. But how exactly do you determine what a startup is worth?
Valuing a startup, particularly in the UK, involves specialised methods that consider potential growth, market size, and key business fundamentals, especially since traditional valuation models may not apply to early-stage companies with limited financial histories.
This guide explains why startups need valuations and explores the most common valuation methods used in the early stages of a business.
There are several reasons why an early-stage company might need a valuation. The objectives can vary depending on the context - sometimes, a higher valuation is beneficial, while in other cases, a lower valuation might be preferred.
Here are the most common reasons for valuing a startup:
Before accepting funding from investors, you need to establish your startup's worth. This valuation helps determine how much equity you should offer in exchange for capital.
A fair valuation ensures:
If you're selling your company, a valuation is crucial to negotiating a fair price. The goal at this stage is typically to maximise the valuation so founders and shareholders achieve the best possible return.
Many startups use equity incentives (such as EMI options in the UK) to attract and retain talent. To issue shares to employees, you’ll need a formal valuation to determine the fair market price and ensure compliance with tax regulations.
If you’re offering share options under an Enterprise Management Incentive (EMI) scheme, obtaining HMRC's agreement on the valuation is advisable to minimise tax liabilities for employees.
When raising investment, it’s important to understand pre-money and post-money valuations:
Pre-money valuation: The value of your company before receiving external investment.
Post-money valuation: The value of your company after new investment is included.
Simple calculations:
📌 Post-money valuation = Pre-money valuation + Investment amount
📌 Pre-money valuation = Post-money valuation - Investment amount
Investors use pre-money valuations to determine how much equity they should receive in exchange for their investment. Since valuations fluctuate over time, these figures are typically reassessed at each funding round.
There’s no universal formula for valuing an early-stage business, but investors and founders typically use a mix of quantitative (financial data) and qualitative (business potential) methods. Here are two of the most common approaches:
This method estimates a startup’s future value and calculates how much an investor should pay today.
Formula:
📌 Return on Investment (ROI) = Exit Value ÷ Post-Money Valuation
📌 Post-Money Valuation = Exit Value ÷ Expected ROI
💡 Exit Value (or Harvest Value): The projected sale price of the business in the future, based on revenue forecasts.
Investors use this model to back-calculate how much equity they need to achieve their target returns.
Also known as the Bill Payne Method, this is commonly used for pre-revenue startups where financial data is limited. It compares a startup to similar businesses in the same industry using key qualitative factors:
Steps:
This method helps investors evaluate risk and potential before investing in startups that don’t yet have extensive financial records.
Startup valuations aren’t an exact science. Different methods apply depending on whether you're raising investment, offering share schemes, or planning an exit.
If you need a valuation for tax purposes - such as for an EMI share scheme - it’s advisable to obtain an HMRC agreement on the valuation to ensure compliance and reduce risk.
Need help with a company valuation? Our in-house team specialises in share scheme valuations. Get in touch today.