Question

What are the difficulties and challenges that investors face in valuing early-stage companies?

Answer 1

Investors face many challenges while valuing early stage companies or startups. Some of these challenges or difficulties are mentioned below:

• Limited Data available – Young companies have limited or no historical data available which make their valuation very difficult. It is thus difficult to estimate the performance or revenue generation from the company when there is an economic downturn in the industry.
• Forecasting- Extensive Forecasting and statistical analysis of the company is required to get an idea about the future sales and earnings of the company.
• Discount Rates – One method adopted by the investors to value a company at its infant stage is the discounted cash flow method or DCF method. Here there are lots of estimation involved regarding the future cash flows generated by the company. Sine there is a very high risk in investing in a startup so a high discount rate is used while valuing it. As there iare lots of estimation involved and it is not error-free, hence DCF method has to be used with utmost care.
• Difficulties in relative valuation – relative valuation is easier when doing for a public traded company because their comparable companies are also public traded companies and historical data is present for these companies. While performing relative valuation for a young company it is often very difficult to find the data for its comparable companies in same business as they are also young companies.