if the investor agrees to invest $1,000,000 in the startup, how much ownership (equity) does that buy? You can calculate the answer in a simple sequence: 1. Assign a value to the startup before the investment dollars are injected. This value is called the pre-money valuation of the startup. 2. Add the investment amount to the pre-money valuation. The result is called the post-money valuation. 3. Divide the investment amount by the post-money valuation to give the equity percentage owned by the investors. This percentage is also called the founder's dilution amount or percentage.

Asset-Based Valuations: This valuation method derives a valuation by adding the total asset value of items including land, property, and equipment, and then subtracting the liabilities of the company. Clearly, this is not a good model for new or growing businesses with very few if any hard assets. It does not take into account the future earnings potential of the business, or other difficult to value items such as patents, code, or brand or market recognition.

Earnings Multiplier Models: Earnings multiple valuation methods compare well established earnings metrics of similar companies in a particular industry and assume similar multipliers apply to your company. This method depends on historical stock prices and earnings data from a relatively large number of peer companies, typically publicly traded companies operating in very similar business segments. These methods can reveal connections such as, "Companies like yours are valued at 12 times your earnings per share." Early-stage startups rarely have revenue and associated earnings needed to for this quantitative method to be a valid measure of the valuation goal.

Quantitative Methods of Accounting Valuations: A quick review shows why these methods do not work for early-stage startups: Discounted Cash Flow (DCF). Using this method, the current value of the company is estimated using future cash flow projections and discounting (adjusting down) the value of those cash flows. As you may recall, having money now is worth more than money in the future. For the accountant or valuation professional to build accurate future cash flows guesses, they look to the past cash flow performance of the company the more years available, the better. The DCF method also depends on accurate cash flow projections-something difficult for early stage startups to predict.

Accounting-based methods are called quantitative because they depend on evaluating the financial reports of the business over a multi-year timeframe. Startups Need Not Apply: As you might be guessing, quantitative valuation methods are not useful for early-stage startups. Why? Quantitative valuation models depend on several years of financial reports as well as forward-looking forecasts. It is not uncommon for a valuation specialist to review three to five years of historical financial reports using the past financial performance to derive revenue and cash flow projections to arrive at a business valuation. Clearly, early-stage startups do not have such financial history to support an accounting based valuation.

Understanding Accounting Valuation Methods: Talk with a CPA or company accountant about business valuation and you'll hear terms such as discounted cash flow, earnings multiples, and discretionary cash flow, Accountants use these and other procedures to evaluate the financial condition, performance, and ultimately place a valuation on a business key point, well established businesses.