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. 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 >>
  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 way to calculate profitability for startups?

    Understand how evaluating profitability at multiple levels is beneficial for startups, including learning the calculation ... 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. Small Business

    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. 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. 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.
  6. 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.
  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. 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 ...
  9. Small Business

    Startups: Tech Giants' Next M&A Targets? (AAPL, GOOGL)

    Watch for large-cap tech sector companies to announce acquisitions of startups, as valuations for unicorns and other overvalued startups continue to decline.
  10. Tech

    Are High Valuations In Silicon Valley Over?

    Silicon Valley valuations, which hit the roof earlier this year, are coming down to earth. What caused the rise? And, what brought about their downfall?
RELATED TERMS
  1. Lean Startup

    The lean startup is a teachable and learnable method for creating ...
  2. Diluted Founders

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

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

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

    Shares of stock reserved for employees of a private company. ...
  6. Jumpstart Our Business Startups Act - JOBS

    An act signed into law on April 5, 2012 that allays the regulations ...
Hot Definitions
  1. Preferred Stock

    A class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares ...
  2. Net Profit Margin

    Net Margin is the ratio of net profits to revenues for a company or business segment - typically expressed as a percentage ...
  3. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
  4. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ability to pay short-term and long-term obligations, also known ...
  5. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
  6. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
Trading Center