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. 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 >>
  4. What is the best form of equity financing for a start-up company?

    Learn the equity financing options available to small business, and understand the best equity options for companies during ... Read Answer >>
  5. How is venture capital different from other kinds of equity financing?

    Learn how venture capital equity financing differs from other funding options and what companies need to be aware of prior ... Read Answer >>
  6. What type of funding options are available to a private company?

    Understand how private companies can obtain financing for startup, growth or expansion projects, and learn how this differs ... Read Answer >>
Related Articles
  1. 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. Tech

    #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.
  4. Tech

    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. Tech

    UK Tech Startups: Proving To Be More Than Hype

    Over the last few years, the explosion of tech startups in the UK has been grabbing an increasing amount of attention from investors around the world.
  6. 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.
  7. Insights

    Falling Startups Are Sapping the Economy

    The declining number of startups is a major drag on the U.S. economy and employment
  8. Retirement

    Funding a Startup with Retirement Cash: Smart or Dumb?

    Retired entrepreneurs who have "played it safe" – and retirees who want to stretch their dollars – are looking to invest retirement funds in startups.
  9. Investing

    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. 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. Alphabet Rounds

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

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

    Shares of stock reserved for employees of a private company. ...
  4. Equity Financing

    The act of raising money for company activities by selling common ...
  5. Bootstrap

    A situation in which an entrepreneur starts a company with little ...
  6. Drive-By Deal

    Slang referring to a deal in which a venture capitalist invests ...
Hot Definitions
  1. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  2. Pro Forma

    A Latin term meaning "for the sake of form". In the investing world, it describes a method of calculating financial results ...
  3. Trumpcare

    The American Health Care Act, also known as Trumpcare and Ryancare, is the Republican proposal to replace Obamacare.
  4. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
  5. Portable Alpha

    A strategy in which portfolio managers separate alpha from beta by investing in securities that differ from the market index ...
  6. Run Rate

    1. How the financial performance of a company would look if you were to extrapolate current results out over a certain period ...
Trading Center