3 Commonly Used Startup Valuation Methods in Vietnam

Although it is extremely difficult to provide an accurate valuation, determining a company's value is a key step in the investment process. The parties rely on the value of the company and the amount of investment to determine their shares in the company and the new valuation level; Then rely on shares to determine other important things such as dividends, voting rights,...

Below, ThinkZone summarizes 3 common methods commonly applied by investment funds in Vietnam.

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We come to the first method, based on the company's contributed capital and assets.

1. CAPITAL-BASED METHOD

With this method, we look at the value of the total assets that the company already owns, these assets may include:

- Capital contributions of co-founders

- Fixed assets such as offices, vehicles,...

- Other forms of assets.

It can be seen that when applying this method we will look to the past, looking at the total value of assets that have been poured into the company. Of course, this is not an accurate valuation number because it only considers past assets, without taking into account any future potential of the company.

In addition, technology startups often do not have many fixed assets, so this method is often not suitable for valuing such startups because the resulting number will be extremely low, not accurately reflecting the company's value.

However, the valuation figure given by the capital-based method will give us a "floor price" to determine the exact valuation later, because if the founder has put 1 million USD into the startup, then the valuation of that startup will usually be over 1 million USD. (Unless the startup is really bad and has almost failed. But if this happens, VCs usually won't invest, and we don't need to value the startup).

2. COMPARABLES METHOD

This is the most common method for valuing early stage companies: Find a company similar to the one you're valuing, then use that company's value as a benchmark for valuation.

 

There are aspects or parameters between similar startups that can be compared. such as MAU (Monthly Active User), GMV (Gross Merchandise Value), or MRR (Monthly Recurring Revenue),...

For example: "Startup X and startup Y have similar business models and products. In particular, startup

With the comparison method, just like when shopping, we look at the prices of similar products (here are startups) to determine whether the price of a product is high or low. Advantages of this method include:

➤ Highly convincing, because it is based on common benchmarks on the market.

➤ Solve the problem of the capital-based method (not considering future potential), because the comparison method uses benchmarks of previous companies, proven by the market.

➤ Simple, easy to understand, does not rely on complex calculations, avoids cheating tricks when setting prices.

However, we also see the weaknesses of this method:

➤ Incomplete information: We often only collect a few indicators of similar companies but do not fully understand them, so the published data may not be accurate.

➤ If your startup is the first model in the market, you will not have similar companies to benchmark, and the benchmark method is based on data from less similar companies in the industry, meaning the error will be higher.

➤ Companies are not exactly the same, so the valuations obtained are often only relative.

➤ Because this method is based on market benchmarks, if the market is in a bubble state (valued higher than real value), your valuation will be too.

To get the most accurate valuation figure possible, we often take benchmark data from many similar companies, and benchmark against many different indicators. (MAU, revenue, GMV,...) to find a reasonable valuation range for negotiation between investors and founders.

3. DISCOUNTED CASHFLOW METHOD (DISCOUNTED CASHFLOW METHOD)

This is a method of valuing a business by predicting the future cash flows of that business and then discounting them to the present time, with the assumption that the value of the business is equal to the total present value of the cash flows that the business is expected to generate in the future.

Specifically, the DCF method values ​​a business based on expectations about that business's capacity in the future. This is different from the asset-based valuation method (based on what the founder has spent since the time of establishing the business, that is, looking back into the past), and comparison method (with similar companies in the market, that is, looking at the present).

--> Readers can refer to the detailed formula for business valuation according to the DCF Method here.

Advantages of DCF

The DCF method values ​​a business based on its financial capacity in the future, so businesses that have historical cash flow data will help predict future cash flows more accurately. And because the DCF valuation formula is built strictly on corporate finance, the resulting number will have a more financial basis.

Weaknesses of DCF

Because valuation is based on a business's expectations about future business performance, this method inevitably comes with the risk of predicting the future. From the formula above, you can see: we need to predict two things, the discount rate r (representing the level of future risk), and the CF cash flows the company is expected to generate.

Forecasting cash flow is difficult due to a number of factors:

➤ Startups in the early stage that have only been established for 1-2 years do not have much past data as a basis for predicting future cash flow;

➤ Many Vietnamese startups do not prepare financial reports properly, leading to a lack of data for prediction;

➤ Unlike traditional businesses with fairly steady growth graphs (for example, 5% growth every year), startups' growth graphs are often very sudden and difficult to predict (for example, the first 2 years grow at 0% and -5%, the third year can suddenly grow up to 20%).

➤ Most early stage startups have very low cash flow, or even no revenue, so the valuation obtained from this method is often very small.

➤ Predicting r is not easy, because no one can accurately predict data such as inflation rate, financial crisis, or even Covid.

Therefore, DCF is often only applied when valuing startups that have reached a certain level of maturity, have clear, stable, and large enough revenue.

SUMMARY

Among the above valuation methods, the Comparison method is the most commonly used method in Vietnam, because of the early stage characteristics of Vietnamese startups.

When valuing a company, investors often evaluate it using many different methods, thereby obtaining different numbers. These numbers help them determine what range the business valuation falls within. And the remaining work is the negotiation between the founder and investors to come up with the final number.