How do you value a tech start up after a prototype has been made?

DWQA QuestionsCategory: Merger, Acquisition, & Joint VentureHow do you value a tech start up after a prototype has been made?
mmPaula Jones asked 1 year ago

I would imagine the traditional valuation methods may not apply in this case.

1 Answers
mmadmin Staff answered 1 year ago

There are two decent methods that can be used for the valuation of an early stage startup with a prototype. They are:

Cost-to-Duplicate
As the name implies, this approach involves calculating how much it would cost to build another company just like it from scratch. The idea is that a smart investor wouldn’t pay more than it would cost to duplicate. This approach will often look at the physical assets to determine their fair market value.

The cost-to-duplicate a software business, for instance, might be figured as the total cost of programming time that is gone into designing its software. For a high-technology start-up, it could be the costs to date of research and development, patent protection, prototype development. The cost-to-duplicate approach is often seen as a starting point for valuing startups, since it is fairly objective. After all, it is based on verifiable, historic expense records.

The big problem with this approach – and company founders will certainly agree here – is that it doesn’t reflect the company’s future potential for generating sales, profits and return on investment. What’s more, the cost-to-duplicate approach doesn’t capture intangible assets, like brand value, that the venture might possess even at an early stage of development. Because it generally underestimates the venture’s worth, it’s often used as a “lowball” estimate of company value. The company’s physical infrastructure and equipment may only be a small component of the actual net worth when relationships and intellectual capital form the basis of the firm.

Valuation by Stage
Finally, there is the development stage valuation approach, often used by angel investors and venture capital firms to quickly come up with a rough-and-ready range of company value. Such “rule of thumb” values are typically set by the investors, depending on the venture’s stage of commercial development. The further the company has progressed along the development pathway, the lower the company’s risk and the higher its value. A valuation-by-stage model might look something like this:

Again, the particular value ranges will vary, depending on the company and, of course, the investor. But in all likelihood, start-ups that have nothing more than a business plan will likely get the lowest valuations from all investors. As the company succeeds in meeting development milestones, investors will be willing to put assign a higher value.

Many private equity firms will utilize an approach whereby they provide additional funding when the firm reaches a given milestone. For example, the initial round of financing may be targeted toward providing wages for employees to develop a product. Once the product is proved to be successful, a subsequent round of funding is provided to mass produce and market the invention.