Those with financial backgrounds always like to see numbers, which, they believe, are the most reliable source of information. For early-stage startup valuation, this belief is especially untrue. While financial experts always prefer to opt for quantitative startup valuations, we want to warn you not to follow blindly.
Here, we’ll outline the main reasons you should use qualitative, rather than quantitative, valuation methods, especially for Early-Stage startups.
The most common quantitative valuation techniques – DCF, EPS, Multiples, comparable, etc., build on sequential assumptions to calculate the value of the enterprise. The more assumptions, however, the less accurate and the less reliable your valuation will be.
If you are an Early-Stage startup, chances are you do not have any historical data from which assumptions can be drawn. While startups commonly combat this problem by using historical data from a similar startup, the move ends up decreasing the overall reliability of such a valuation.
Getting a quantitative valuation will focus the founding team’s attention on sales, and, in turn, they’ll feel pressured to reach the sales goals set for them by such assumptions. While selling is, of course, one of the most important goals for a Startup, it is not the only one. By focusing disproportionately on the sales aspect of your startup, you’re increasing the risk of failure
If you’ve ever taken an economics course, then you know what Ceteris paribus means. If not, it simply means that when you’re studying the relationship between two factors, you assume that all other factors stay the same. This same logic is used by quantitative methods that make sales assumptions without taking into account other factors that might interfere with actual sales, such as internal or external emergencies.
Qualitative valuation methods focus on measuring the value of a startup’s intrinsic attributes, such as the founding team’s qualifications, the innovativeness of the Startup’s product/service, and the legal status of the Startup, among other things.. These valuation methods are more reliable as they measure what value the startup currently has, rather than focusing on the future value it may generate.
Most quantitative valuation methods follow a top-down approach to valuation. The first step investors should take is to identify how much return they would like to make on their investment. This Is the logic that drives the valuation and investment amounts that they assign to the startup. This not only harms the Startup but also ends up hurting investors who fail to guide the startup to success.
If you go into the details of qualitative valuation methods you will see that these same methods could also be used as guidelines that could serve as a startup’s compass. These methods could help to point out the startup’s strengths and allow founders to capitalize based on the strengths and weaknesses identified. Such knowledge helps to give founders a chance to improve in areas they may have otherwise disregarded.
While qualitative valuation methods incorporate sales and future revenue potential into valuation calculations, it is not the only factor upon which the valuation is based. Instead, qualitative valuation methods can, and do, eventually result in numbers that make it easier to present the results. This is just to say that qualitative valuation methods include the essential parts of a quantitative valuation, though not the other way around.
We have worked to build an automated, AI valuation calculator that relies on globally recognized, investor-devised qualitative valuation methodology. Try it out for free.