A:

A startup is a young company that is just beginning to develop. Startups are usually small and initially financed and operated by a handful of founders or one individual. These companies offer a product or service that is not currently being offered elsewhere in the market, or that the founders believe is being offered in an inferior manner.

In the early stages, startup companies' expenses tend to exceed their revenues as they work on developing, testing and marketing their idea. As such, they often require financing. Startups may be funded by traditional small business loans from banks or credit unions, by government-sponsored Small Business Administration loans from local banks, or by grants from nonprofit organizations and state governments. Incubators can provide startups with both capital and advice, while friends and family may also provide loans or gifts. A startup that can prove its potential may be able to attract venture capital financing in exchange for giving up some control and a percentage of company ownership.

Because startups don't have much history and may have yet to turn a profit, investing in them is considered high risk. Here are some ways that potential lenders and investors can value a startup in the absence of revenues:

  1. The cost to duplicate approach looks at the expenses the company has incurred to create its product or service, such as research and development and the purchase of physical assets. However, this valuation method doesn't consider the company's future potential or intangible assets.
  2. The market multiple approach looks at what similar companies have recently been acquired for. The nature of a startup often means that there are no comparable companies, however. Even when there are comparable company sales, their terms may not be publicly available.
  3. The discounted cash flow approach looks at the company's expected future cash flow. This approach is highly subjective.
  4. The development stage approach assigns a higher range of potential values to companies that are further developed. For example, a company that has a clear path to profitability would have a higher valuation than one that merely has an interesting idea.

Because startups have a high failure rate, would-be investors should consider not just the idea, but the management team's experience. Potential investors should also not invest money that they cannot afford to lose in startups. Finally, investors should develop an exit strategy, because until they sell, any profits exist only on paper.

RELATED FAQS
  1. In the context of a startup, what is sustainable growth?

    Understand what sustainable growth means for a startup. Learn what a startup needs to do if its growth rate is above or below ... Read Answer >>
  2. How important is sustainable growth for the long-term future of a startup?

    Understand the importance of sustainable growth to the long-term future of a startup. Learn the benefits and drawbacks of ... Read Answer >>
  3. What are examples of products and companies that rely on protective tariffs to survive?

    Discover the best way for a startup to have sustainable growth. Startups that fail burn too much cash and are unable to respond ... Read Answer >>
  4. How do venture capitalist investors view sustainable growth in a startup?

    Discover how venture capital investors view sustainable growth in a startup. Venture capitalists look to identify startups ... Read Answer >>
  5. What is the best way to calculate profitability for startups?

    Understand how evaluating profitability at multiple levels is beneficial for startups, including learning the calculation ... Read Answer >>
  6. What are the due diligence basics for investing in a startup?

    Learn about due diligence basics for investing in a startup, which includes an exit plan, a harvest strategy and evaluating ... Read Answer >>
Related Articles
  1. Entrepreneurship & Small Business

    Investor Info for Internet-Based Tech Startups 

    With all the empty startup hype and vast number of options out there, how do you sift through the noise to find the best startups to consider for investment? Start here.
  2. Managing Wealth

    How Startup Ventures are Valued

    It’s difficult to value a company in its infancy, but it’s important to determine a startup’s worth, whether you’re a founder or an investor.
  3. Investing

    5 Questions to Ask Before Investing in a Startup

    Investing in start-ups can be profitable but investors need to do their homework before diving in.
  4. Managing Wealth

    The Risk And Rewards Of Investing In Startups (GOOG)

    Investing in startups is a very risky business but can reward investors greatly if and when they do pay off.
  5. Managing Wealth

    #1 Country For Tech Start-Ups: U.S.A

    U.S. tech companies are receiving increased levels of investor funding. In 2014, the number of mega-deals for such ventures doubled over the previous year.
  6. Managing Wealth

    Germany Tech Startups: Keep Them On Your Radar

    Many German companies, which are eager to catch up with the rest of the world by entering the digital age, are investing in tech startups.
  7. Trading

    Retirement Funds To Fund Startups

    Retired entrepreneurs who have "played it safe" and retirees who want to stretch their dollars are looking to invest here.
  8. Entrepreneurship & Small Business

    Declining Venture Capital Offset by Digital Economy

    While the amount of venture capital may be on the decline this new trend certainly does not seem to present a problem for tech startups in today's growing digital economy.
  9. Markets

    Will Tech Stocks Survive Higher Interest Rates? (AAPL, GOOG)

    Learn why large tech companies such as Apple and Google are likely to not be impacted by interest rate increases, but newer tech startups could have problems.
  10. Entrepreneurship & Small Business

    Why Are Startups Going International?

    Expansion into international markets, if it occurs, is the final stage of a startup's evolution. Lately, though, the opposite has been happening; international expansion now occurs fairly early ...
RELATED TERMS
  1. Startup Capital

    Startup capital refers to the money that is required to start ...
  2. Startup

    A company that is in the first stage of its operations. These ...
  3. Diluted Founders

    A slang term often used by venture capitalists to describe the ...
  4. Alphabet Rounds

    The early rounds of funding for a startup company, which get ...
  5. Venture Capital

    Money provided by investors to startup firms and small businesses ...
  6. Option Pool

    Shares of stock reserved for employees of a private company. ...
Hot Definitions
  1. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  2. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  3. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  4. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  5. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  6. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
Trading Center