Valuing Young, Start-Up and Growth Companies: Estimation Issues and Valuation Challenges

Abstract

Young companies are difficult to value for a number of reasons. Some are start-up and idea businesses, with little or no revenues and operating losses. Even those young companies that are profitable have short histories and most young firms are dependent upon private capital, initially owner savings and venture capital and private equity later on. As a result, many of the standard techniques we use to estimate cash flows, growth rates and discount rates either do not work or yield unrealistic numbers. In addition, the fact that most young companies do not survive has to be considered somewhere in the valuation. In this paper, we examine how best to value young companies. We use a combination of data on more mature companies in the business and the company’s own characteristics to forecast revenues, earnings and cash flows. We also establish processes for estimating discount rates for private capital and for adjusting the value today for the possibility of failure. In the process, we argue that the venture capital approach to valuation that is widely used now is flawed and should be replaced.

Keywords: valuation, growth companies, venture capital approach