Downturn In eCommerce Funding And Startup Valuations
Present Industry Landscape for Startup
The Internet-based businesses globally have seen unprecedented growth and now with India taking a center stage in global markets, many Indian startups have come out, especially in the last couple of years, (substantially Tech-enabled) to solve a multitude of problems we face in our daily life.
Till 2015, Indian digital retail and eCommerce companies and their valuations were being closely linked to the soaring valuation of US tech start-ups and investors are under the fear of missing out. The online retail companies were relying on a different metric of valuations – “GMV” which is defined to indicate total sales value for merchandise sold through a marketplace over a period.
However, it must be noted that GMV is not reflected on their financial statements and their actual revenues are just a fraction of GMV. The GMV or sales (as per financial statement) is then multiplied by a multiple (x times) to get the Valuation of the entity.
Interestingly the trend of Investments has remained difficult and different in 2016. Many e-tailers have reported decline in number of orders significantly as they cut discounts leading to drop in their GMV raising eyebrows on their fresh funding rounds as Investors are looking when ventures would turn profitable leading to diminution of their valuations.
Approaches for Business Valuation
For valuing mature companies, there are broadly three approaches to valuation namely Asset Approach, Income Approach & Market Approach
However these approaches do not find much of relevance for valuing the Start-ups as they often have insignificant revenue or EBITDA metrics, insufficient history, no meaningful comparable(at their stage) and long term income/ cash flow projections are quite difficult to estimate.
Valuation Methodology for start-ups
These valuation methodologies for startup are different in the sense that: Venture Capitalist(VC) Method works backward to calculate the % shareholding VC should get, once it’s been decided how much amount needs to be invested in any venture.
First Chicago Method takes into consideration three business scenarios: Success, Failure and Survival case and associate probability to each case depending on a number of factors like Promoters, Team, Traction, Competitive advantage, Strategy etc. to find the futuristic value of a start-up under the most likely set of parameters and its business model. In nutshell, this method gets benefit of averaging under different scenarios that a startup may end with.
Adjusted DCF Method judges the value of a start-up on the basis of its potential which is translated in the form of estimated future cash flows discounted at appropriate cost of capital today.
The adjustments here relate to validation of the revenue and expenses vis-à-vis historical average and peers and use of differential discount rates depending upon the stage of operations and inherent risk of the business model at that stage (like pre and post development of a product).
Startup valuation depends a lot on qualitative factors like Founders and Co-founders background, experience and passion, Solution and Strategy to a problem (Biz Model), Scalability potential of business (with or without technology), Competitive landscape, Current Traction and Scalability potential of business. Start up’s often operate in the valley of death which requires considering the probability of their success and failure. In a way, Start-up valuation also involves validation of business model which makes it complicated vis-à-vis other valuations. As everything is future driven in start-up, the experience of values plays a significant role in value conclusion in the absence of track record and financial history,it’s certainly an art, not science.