Updated: Nov 11, 2021
The phenomenal pace of startups and their innovations - whether it is in the manufacturing or IT sectors, has resulted in a big surge of highly valued and as-yet-unlisted companies in the last two years. We found out the method behind how this is done.
Indian Startup Ecosystem
As the third largest startup ecosystem in the world, India incubates over 50,000 startups every year and has been witnessing a 15 percent growth year-on-year. The advancement of Indian startups have already accelerated past those of developed economies such as Germany and the United Kingdom and it isn’t showing signs of slowing down. Being the hub for modernisation and skilled labor, Indian startups attract investments from around the world.
Image credit: Stocksnap
With $106 billion worth of value creation by 44 unicorns, the startup ecosystem is a kind of revolution in itself. It has created 1.4 million direct and indirect jobs, a study shows. Investments in early-stage Indian companies are attracting a lot of interest across the world. “The number and size of successful start-ups is on the rise; investors have never seen unicorns at such unprecedented levels,” notes KPMG in its recent newsletter.
The startup capital flow was robust during the pandemic as lakhs of people took to ordering everyday items such as grocery, clothing, stationery and medicines online. This also meant tech startups got a better value for their businesses than they did a year ago.
“The pandemic has been a boon for tech firms. Increased digital consumption has led to ballooning valuations and soaring interest in tech-based investments with the year witnessing over 75 percent investment in start-ups, e-commerce, IT and ITeS sectors,” said Prashant Mehra, Partner, Grant Thornton Bharat LLP in a note to the clients.
Well, there are several methods used to arrive at a fair valuation for a startup. Each one of them requires an enormous seed capital and funds to fuel the different stages of their growth. If a startup inflates its valuation, it risks repelling venture capitalists and other investors who can see through the farce.
Hence, it becomes extremely crucial that one values their startup in fact and not foam. Below are a few methods that are used to evaluate a startup.
Some of the startup unicorns in India
Startup Vauluation Methods:
Usually there are four methods in which startups can be valued that is, Berkus Method, Cost-to-Duplicate Approach, Discounted Cash Flow Method and Venture Capital Method. Take a look at all the four methods below.
Venture capitalist David Berkus came up with a method to assess the valuation of startups based on five key metrics. These include the basic value, which is the value of the idea on which the business runs. Second is the technology or prototype that the startup holds, third is quality of its management and fourth is the relationships in their core market. The final metric is the production cycle and sales.
Startup founders calculate the expenses incurred to recreate their entire business, from cash spent on research to acquiring physical assets, in this method. It is one of the most popular methods used to evaluate a startup, but fails to capture the valuation of intangible assets such as goodwill, brand power, customer engagement and future potential.
Discounted Cash Flow Method
Every startup runs several risks, many times, this is more than existing businesses. If the return on investment is greater and outweighs the risks, then any investor would be happy to put their money in such a company. In this method, one calculates the discounted cash flows of the business in an estimated period. On this, the return on investment is applied to reach the valuation.
Venture Capital Method
One of the most popular methods followed by venture capitalists in assessing a startup’s valuation is by calculating the price at which the business can be sold and the return on investment.
Sharp rise of unicorns in 2021
A privately held startup company valued at over $1 billion, is referred to as a unicorn in the venture capital industry. Records were broken when around $1.55 billion was raised by six Indian startups between April 5 to 9, 2021. In 2020, just 12 unicorns were born, which itself was the highest ever in a year in India. But, 2021 has so far seen the birth of 10 unicorns.
The six deals announced in April included PharmEasy (healthcare), Meesho (social commerce), Groww, Cred (fintech), Gupshup and ShareChat (social and content platforms). The other four unicorns born in 2021 are – Five Star (banking), Innovaccer (software), Infra Market (infrastructure) and Digit (insurance). The valuation of these unicorns ranges from $1 billion to $2.2 billion. New York based Tiger Global has emerged as one of the most aggressive investors with investments in four of the six new unicorns in April, 2021.
The country added three unicorns per month this year to nearly double the overall number of startups valued over $1 billion as of August, according to the Hurun India report.
“Fast-growing and innovative (unlisted) firms are sprouting up in new sectors as well as locations across the country, rapidly gaining momentum as they ride unique growth opportunities from digital public infrastructure and partnerships,” said Neelkanth Mishra, Co-head of Equity Strategy, Asia Pacific and India Equity Strategist at Credit Suisse.
Edited by Roshni Shroff
Cover image illustration by Jyothi Syam
Some resources to understand startup valuations better: