Valuation Essentials: Framework for Fintech Pricing

For a fintech start-up or scale-up, valuation is crucial. It plays a significant role in major financial events such as sales, mergers, funding rounds, or employee stock option plans. Essentially, valuation determines the price assigned to a business at a specific point in time. For instance, during a funding round, it dictates how many shares an investor receives for their capital and thus the dilution percentage for existing shareholders. Similarly, in the event of a sale, it defines the price the acquirer will pay for the company.

Valuing a private business is not an exact science. As with publicly traded companies, a company’s total valuation (i.e., share price multiplied by the total number of shares) depends on investors’ perception of future cash flows. Since no one can predict the future, valuation always involves some degree of estimation.

However, established frameworks exist for evaluating companies. For more mature financial services companies, valuation typically relies on multiples of current yearly revenues and profits, assuming future revenues and profits will align with past performance.

Two common methods include:

• The Discounted Cash Flow (DCF) method, which estimates a company’s value based on projected future cash flows (typically over the next five years or longer), discounted back to their present value.
• The Revenue Multiple Method method, frequently used for valuing SaaS companies, applies a multiple to Annual Recurring Revenue (ARR). For high-growth, subscription-based companies, the industry-standard revenue multiple typically ranges from 8x to 15x ARR, depending on growth rate, profitability, and market potential.

For fintech start-ups or scale-ups that are often unprofitable and have minimal revenues, these methods may not apply. In such cases, potential growth opportunities must be estimated, using several steps:

• Step 1: Assess the total addressable market size, both today and in the future (if growth is expected). This gives an estimate of the potential revenue a company could generate.
• Step 2: Estimate what percentage of this addressable market the company could capture. If average revenue per customer in the target market is known, you can project potential revenue. This step heavily depends on the competitive landscape—stronger competition makes it less likely a company will capture a significant market share.
• Step 3: Estimate future costs (e.g. Customer Acquisition Costs) and profitability to evaluate the company’s path to profitability.

In addition, it’s important to quantify all current assets, such as:

• Intellectual property (IP) — proprietary technology, patents, or unique algorithms. The company’s vision and developed product can also add value, even if they’re not legally protected.
• Leadership and team quality — the expertise and experience of the company’s leadership and employees.
• Customer base — size, diversity, and engagement. Companies with loyal customers, low churn rates and high Customer Lifetime Value (CLV) are viewed as more stable and typically command higher valuations.
• Partnerships — any strategic relationships or partnerships.
• Cash and assets — available cash reserves and other assets, which could be monetized if needed.
• Brand value — factors like the founders’ track record, thought leadership content, awards, and previous investors can all enhance the company’s brand.

One commonly used method for valuing start-ups without hard financial data is the Berkus method. This method assigns a value (typically between $0 and $500,000) to five factors: the strength of the idea, the quality of the founding team, product progress, strategic relationships, and sales milestones. Since the Berkus method caps each factor at $500,000, it’s mainly applicable to smaller start-ups, with a maximum valuation of $2.5 million.

The valuation methods mentioned so far are internally focused, based on the company’s own data. But in many cases, external comparisons are also used. The Comparable Company Analysis (CCA) method compares a company’s valuation to that of similar companies. While simpler, it assumes that the other companies have been correctly valued. In cases of market bubbles or hype, this can lead to unrealistic valuations for an entire sector, as everyone looks to others for benchmarks.

As you can see, valuation is more art than science. However, for fintech founders, it should be approached like a "sales" process. Just as when selling a product, in a valuation process you are effectively selling your company — aiming to present it in the best possible light and achieve the highest valuation. On the other hand, the interested party (e.g. investor or acquirer) will seek the lowest valuation, leading to a negotiation. A unique situation arises during later funding rounds when existing investors may also participate. In this case, they find themselves on both sides of the valuation spectrum — wanting a high valuation as existing investors and a lower valuation as new investors. This dynamic adds to the subjectivity of the process.

It’s important to remember that while valuation is critical for financial events, in the day-to-day running of a fintech start-up or scale-up, it has no direct impact. Moreover, a valuation remains theoretical until it is realized through a sale, merger, or IPO.

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