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How Startups Can Reach Billion Dollar Valuations

photo by Philippe Lewicki via Flickr.

With dollar amounts reaching into the tens of billions, startup valuations can sometimes seem overzealous. But just where do these valuations come from?

The startups

Before we talk about the process behind how budding new startups are valued, it may be important to look at just how valued some of them are.

Below are three of the most highly valued startups in the world.

1.) Xiaomi

Latest valuation: $46 billion (Dec. 2014)

Founded in 2010, chinese smartphone producers, Xiaomi, have risen to become the world’s most valuable tech startup.

2.) Uber

Latest valuation: $41 billion (Dec. 2014)

Transportation startup Uber has taken the U.S. by storm with its on demand can service. Since their start in 2009 they have exploded to the second highest valued startup in the world.

3.) Palantir

Latest valuation: $15 billion (Nov. 2014)

You may not have heard of Palantir, but that’s because you’re not supposed to. Both the FBI and the CIA use Palantir to digest large amounts of data mined for intelligence purposes.

How startups are valued

For startup founders and venture capitalists (VC), valuations generally follow a standard equation–the startup’s revenue multiplied by how much an investor expects in return.

For example:

$1 million in funding with an expected 10x return will result in a valuation of $10 million.

This is a fairly straightforward format which is used quite commonly.

How an investor calculates their expected return, however, can be much more in depth.

At the end of the day, a startup’s value is driven most prominently by the interest of market investors. This means that the more investors intent on funding a given company, the higher its valuation will go.

So the question becomes essentially, how do investors decide how much they will invest?

Below are 5 driving factors that influence an investor’s expected return, and therefore a startups valuation.

Factors in valuation

Demand

When startups are gaining traction, there is usually a certain amount of domino effect that comes into play. Specifically, this means that the more investors interest, the more attractive the startup becomes.

Since first-round funding is limited, investors will often vie for chances to involve themselves in a startup early on.

Founders

The level of expertise that a startup’s founders bring to the table may also impact the valuation significantly.

For instance, if Jeff Bezos of Amazon is the mastermind, the startup will likely attract more funding than your next door neighbor.

Revenue

Revenue, though not always the most important aspect of valuing a startup, can go a long way in influencing potential investors.

It should be noted, however, that revenue isn’t always a good indicator of just how profitable a company will be, since revenue only accounts for how much money a startup brings in, and not their operating costs.

This factor is also often overshadowed by other aspects like growth and potential.

Growth

When a VC is interested in investing into a startup, growth is often one of the most enticing factors.

For instance, if an app is growing 30 percent more users per month, it will likely be worth more than one that is growing 15 percent.

Competition

Since competition may very well butt heads with growth, it is an equally important factor for a VC determining whether or not to invest in a startup.

The more competitors in a space, the harder it may be to pitch one’s business.

The takeaway

With startups like Xiaomi, who make smartphones, valued at $46 billion (more than companies like Twitter and Cannon) how valuations work can be an intriguing and sometimes questionable topic.

One thing is certain, however: the most valuable startups are the ones that offer services that are both unique and profitable.

We measure success by the understanding we deliver. If you could express it as a percentage, how much fresh understanding did we provide?

 

James Pero