Startup valuation metrics: how to convey your value to investors

The evaluation of a startup is a major topic for investors, and as a result any startupper must master it if they want to find funding for their project and see their merits properly recognized.

Evaluating a startup is obviously much more difficult than evaluating a mature business, especially when the startup is in its early stages. There are, in fact, different positions on the best method to use, sometimes conflicting, and striking cases of exaggeratedly underestimated or overestimated valuations of some startups in the face of actual results over time often make the news.

Why the evaluation of a startup is important

For a startupper, knowing the value of his or her entrepreneurial activity is crucial for presenting oneself knowledgeably to potential investors or lenders and having benchmarks without being at the mercy of others' estimates. But also to monitor the progress of the project and identify strengths and weaknesses to act on.

In the early stages of a startup's life, when there are still few numbers, or none at all, valuation is particularly subject to variability and sees quantitative and qualitative parameters mixed together. Especially at this stage, knowing how to provide credible and reasoned valuations is a strategy for conveying one's value (real and potential) effectively to potential investors.

The evaluation of a startup is the information that allows calculating the percentage of each equity stake to be assigned to equity investors. It is therefore an essential preliminary step for any equity financing operation and capital increase.

KPIs: what they are and what they are used for

KPIs are Key Performance Indicators, used to monitor and measure the performance of a specific business or activity and demonstrate their validity. There are countless of them, but not for all activities do they all serve; in fact, it would be extremely counterproductive in terms of time and data relevance not to make a proper selection of KPIs that are truly meaningful to one's business.

In practice, KPIs or metrics are numerical values that summarize the results achieved by certain activities in relation to their objectives (gaining revenue, acquiring data, acquiring customers, etc.). The data on which they are based depend, of course, on the type of activity, and can be, in addition to simple sales data, customer feedback, actions taken by the users to whom an activity was targeted, the abandonment rate of a website, the click-through rate on a given piece of content, etc.

Often metrics work well when used in pairs, that is, comparing two metrics with each other to obtain a third data point that is more significant than the first two taken individually. 

The main KPIs useful for evaluating a startup can be divided into three categories:

• validation
• performance
• financial.

These are all quantitative metrics, while qualitative metrics are, for example, customer reviews, but on their own they have little value because they are subjective, often inaccurate and exposed to outside influences. They can be used in conjunction with quantitative metrics.

Validation metrics

Validation metrics are useful when launching a new product in the market or just after launch, to assess market response and identify product weaknesses and strengths.

Some examples:

• conversion rate, which is the percentage of people who took a desired relevant action out of the total number of people exposed to the stimulus (an account registration, sharing, using a service, downloading a piece of content, purchasing or testing a product/service, etc.).
• retention rate, which is the percentage of customers retained over a given period of time under consideration.
• churn rate, which is the percentage of customers lost in a given period of time.

Performance metrics

Performance metrics, on the other hand, monitor the performance of a business and therefore relate primarily to businesses that are growing but have already been in the market for a sufficient period of time to have cost and revenue data.

Some examples:

• Customer acquisition cost, which is all expenses incurred in acquiring a single new customer (marketing, sales, employee expenses);
• lifetime value, which is an estimate of the revenue a customer will bring in over time, based on average monthly/annual buying habits for each customer;
• monthly recurring revenue;
• daily active users/monthly active users, which is the frequency of online interaction with a service offered by a software or an ecommerce. It measures the level of engagement.

Financial metrics

Financial metrics are primarily used to verify the economic viability of a business model and thus demonstrate its feasibility in view of raising funding. On the basis of these KPIs, moreover, the amount of resources needed for a startup can be knowledgeably defined. In more advanced stages of growth, financial metrics serve internally to optimize budget management and externally to demonstrate the viability of the business.

Some examples:

• Gross profit margin, which is the ratio of production costs to revenue;
• cash burn rate, or the amount of economic resources spent on regular activities and growth in a given period of time (usually per month);
• liquidity ratio, which is the ability of the enterprise to pay its liabilities with the cash on hand.

How to make the most of KPIs

Data are crucial, but one must know how to interpret and use them. First, as we have already mentioned, it is important to know what data are needed and to leave aside superfluous or misleading data.

The early stages of a startup's life are useful for startuppers to get to know their project thoroughly: to understand what metrics are meaningful for a business, you must be clear about its nature, its distinctive characteristics, its short-, medium-, and long-term goals, and its target audience of both customers and investors.

At that point you will have a clear idea of the starting point and the end points (it is never just one!) and possess the tools (i.e., metrics) to measure the progress made. A measurement that must be constant, regularly cadenced and carefully monitored throughout the life of the enterprise, as well as adapted to changing needs and activities.

It can be useful, especially for startups, to have an "outside eye" that provides a professional look at a company's valuation, giving support in identifying the most relevant metrics and in using and cross-referencing the data collected. There are integrated consulting services that provide a professional overview that allows for the fullest use of all phases of a startup's valuation: the metrics used in the process go into building the company's identity card and defining critical points of intervention; the economic value that results from the valuation goes into framing growth expectations and supporting the startup's presentation to investors. The result achieved is twofold: control and efficiency of internal processes and structuring the strategy to access external financing.

Raising funding for startups: many possible avenues

Once you know what you're worth, it's time to let everyone else know it too. Data, business plans, pitches, pre-money valuations will serve you well in gathering the much-needed financial resources that are the weak point of all startups. Without funding, in fact, you will not grow.

The good news is that there is more than one viable avenue for startups to raise funds for growth. Different roads are better suited to different stages of a startup's development, and it is useful to prepare a funding plan from the outset that considers them all.

The era of bank lending as the only option for doing business is over, and while raising funding for a startup may seem more laborious today, thanks to the many alternative finance tools it is also more efficient.

The fintech world offers opportunities such as SAFE or crowdfunding to raise funding for startups while simultaneously creating a network of qualified and loyal investors and structured marketing and sales processes (but not only!). This requires learning more about the regulations on these alternative finance opportunities and organizing activities to define, engage and manage investors over time, which can be done in-house or with the collaboration of external consultants and agencies to support the team. It is clear that raising capital, the primary goal and a sticking point for every startupper, is but the tip of the iceberg: first you need to focus on everything underneath, from evaluating a startup to defining the processes to support growth.