Facebook, Tumblr, Twitter, Instagram, Spotify, Pinterest, and the list goes on: It’s starting to seem like billion-dollar startup valuations are no longer that big a deal to achieve. But how does a young company get a billion-dollar price tag?
Putting a price tag on a young startup is a peculiar practice. While valuation models exist, many agree that it’s more of an art than a science, especially in the absence of revenue — if you’ve ever wondered how Instagram reached a billion dollar valuation without literally ever having made a cent, you’re not alone.
When a company is producing a profit or revenue, valuations can be based on thumb-suck math like five to ten times annual profit, or three to four times revenue. Great, but what if you were a VC in the early days of Twitter, Facebook, Pinterest, or Instagram?
A savvy investor will look at a bunch of stuff like the founding team’s track record, for example. The market the startup plays in is important — similar startups are templates for valuations, revenues or exit potential — and illustrating traction (growth), is a positive signal.
The below infographic by San Francisco-based startup organization Funders and Founders details how a startup is typically valued. A valuation is simply an estimated value of a company and is often based on assumptions about a startup’s potential. It’s not an exact science, explains Anna Vital, the author of the infographic in a blog post. A company’s valuation is important because it can determine the percentage of the company that should be given to an investor in exchange for cash, Vital says.