When it comes time to get your startup valued, you should avoid the wrong and instead strive for the right way to do it. Here’s a quick guide:

👽 Skip discounted cash flow (DCF): DCF requires stable cash flows, which startups aren’t likely to show. Therefore, DCF is useful for mature companies, but not startups, that produce irregular cash flows.

🪢 Don’t use multiples: You can’t use valuation multiples of revenue (five times revenue) or EBITDA (20 times EBITDA) because either you can’t provide the numbers or they are still too small to get the valuation you want.

🎃 Ditch fancy methods: The Chicago Method and scorecards? They haven’t been used by most startups in years.

👑 The right approach: Venture capital method. The venture capital (VC) Method is the way to go. This approach links your valuation to investor assessments of projected returns to their capital. Simply put, investors will assess your business based on what it can do for them, ie, generate substantial returns. The VC method is straightforward and focuses on the future potential rather than current numbers.

📘 How to use the VC method

Choose preferred ownership: What percentage of the business are you willing to give up for the amount you are raising?

Estimate future value: Estimate the future value of your startup at the exit in case you decide to sell. For most cases, this will be five to seven years from now.

Calculate required returns: Investors like me want high returns (10x or more). You can use this to back-calculate the current valuation.

If, for instance, your target goal is a $50 million exit in 5 years and an investor is looking for a 10x return, you should be valued at $5 million right now. 

By valuing your company through the VC method, you are speaking the investor’s language and doing so with a compelling valuation that actually makes sense to the investor. The VC method also makes the valuation process less daunting and increases your probability of success in raising capital.