After shark tanks’ recent popularity, many startups are now targeting to appear on the show’s upcoming season to present their business pitches and growth potential. In the previous season of shark tank, many entrepreneurs were successful in winning a handsome investment from the judges, whereas many failed to attract their attention. Among failed pitches most were from the entrepreneurs who couldn’t identify a reasonable valuation of their product/company. The judges accused these pitchers of throwing some random illogical figure as their company’s or product’s market valuation. It annoyed the judges so much that they simply rejected such pitches.
India has the 3rd largest startup ecosystem in the world after the US and China. It is expected to witness YoY growth of a consistent annual growth of 12-15%. India has over 61,400 startups recognized by the Department for Promotion of Industry and Internal Trade (DPIIT), with at least 14,000 recognized during fiscal 2022, according to an Economic Survey 2021-22. Unfortunately, around 90% of the startups fail, wherein 10% of the startups fail within the first year and 70% of the startups fail during two through five years. The number one reason (around 42%) why startups fail is due to misreading market demand whereas the second largest reason (around 29%) is due to running out of funding.
Reading the market demand correctly before working on an idea or designing a product is highly recommended to avoid wastage of effort and investment. Knowing the correct valuation of market and your product in the market comes handy during fundraising through venture capitalists. Unfortunately, most of the startup founders aren’t well versed with the techniques for valuation computing techniques. We discuss below some of the most common techniques to calculate the valuation of a product or company:
This approach is based upon the concept of replacement cost as an indicator of value and the idea that an investor would pay no more for an asset than what it would cost to replace the asset with one of equal utility. The theory behind the asset approach is as follows: current value of all assets (tangible and intangible) – current value of all liabilities = current value of the company’s equity. This method does not necessarily give an indication of the economic benefit derived through ownership and utilization of the subject product/company. Rather, it provides an absolute minimum value for the subject product/company.
This approach attempts to value an IP by examining recently observable market values for similar assets. This approach is best if an active market exists that can provide several examples of recent arm’s-length transactions that include adequate information on their terms and conditions. Investors value this method for two reasons: First is, even if your idea/product is sub-par at present, a rapidly rising market will increase your revenue, and buyers today will become sellers in a few years. Second, these investors bought something with growth potential, and they'll want to sell something with growth potential.
This approach attempts to value a product/company by estimating the present value of the future economic benefit it is expected to produce. This approach is one of the most widely used methodologies in intangible asset valuation because the information required is often reasonably accurate and readily available.
The two most frequently utilized methods of the income approach are as follows:
Capitalization of Cash Flow (CCF) Method
The CCF method is a single period valuation model that converts a company’s benefit stream into value by dividing it by a rate of return that is adjusted for growth (capitalization rate). This method is used when the company expects long-term, stable cash flows into perpetuity. When this method is used, the valuator uses the recent historical results of the company as a proxy for future operations.
Discounted Cash Flow (DCF) Method
The DCF method is a multiple period valuation model that converts a future series of benefit streams into value by discounting them to present value at a rate of return that reflects the risk inherent in the benefit stream. This method is based on the theory that the value of a company is equal to the present value of its projected future benefits over a specific period, plus the present value of a residual value. To execute this method, the valuator uses forecasts or projections for the company (which are typically provided by management). If you believe your historical results do not capture the anticipated growth of your business, this method would be useful to determine the company’s value.
A proper valuation requires the consideration of all the available approaches when determining a value. However, each method has certain limitations, and although each of the approaches should be considered, it is acceptable to dismiss an approach if there is valid reasoning behind doing so. Additionally, based on the purpose of the valuation, modifications can be made to the types of approaches applied, which may allow you to reduce the amount of work needed as well as the engagement fee. It is recommended to review all the options with an expert to determine the needs for your valuation and the most applicable methods. You can be best prepared by understanding the purpose of your valuation, standard of value and level of value. It is wise to understand the application of applicable techniques as well as the necessary discounts to value.
Boolean IP provides high-quality IP solutions to startups and innovators. Since inception, Boolean IP has been consistent in its approach to fulfilling clients’ expectations. Boolean IP’s Patent and Technology Valuation service is designed to help startups understand the true value of their technology and ideas. We follow a hybrid approach wherein we conduct valuation by taking in account both the qualitative parameters (such as uniqueness of technology, scope/depth of the technology, patent enforceability, competing technologies, feasibility, and acceptance etc.) as well as quantitative parameters (such as market size/share, annual turnover, remaining life of patent, future cash flow, discount factor and absolute profit etc.).
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