The internet era has enabled a whole new class of startups to disrupt, innovate and create the future. With the advancement of technology, a new breed of fintech startups has emerged that aim to fundamentally transform the existing financial services landscape from top to bottom. Today, startups are valued at record-breaking levels, and investors are throwing around big numbers to fuel these valuations. It is essential to have in-depth knowledge about the valuation multiples that are in use in the market. Since new and better valuation methods emerge over time, it is important to have a practical understanding of the basics as well as current practices. This article aims to capture the basics of the current valuation methods and shed light on some of the factors to consider in fintech valuation.
Understand the fintech industry or startups
Before digging in, it is essential to have a basic understanding of the fintech industry and startups. The term 'fintech' refers to the application of financial technologies that involve the use of technology to develop new financial products and services for use. Fintech startups aim to use technology to disrupt the existing financial system and provide solutions for traditional problems in a better, more efficient way.
A startup is typically defined as an early-stage venture that aims to turn a bright idea or new technology into a profitable business. The fintech industry has been growing rapidly and is expected to reach $332.5 Bn with a CAGR of over 19.8% from 2022 to 2028. This growth is driven by the application of technology and innovation in payment processing, innovations in the field of lending, access to financial products and services, and increased customer engagement. Thus, the tech-finance space is a rapidly growing market that provides a perfect chance for startups to make a mark.
Latest fintech valuation trends
As the fintech industry matures and new startups emerge, the valuation trends are heading towards increased sophistication. In today's fast-changing environment, investors have started to evaluate startups based on their fundamentals and cash flows rather than just their potential. With a more practical approach to valuation, investors are now focusing on metrics such as user growth, subscriber retention, and customer satisfaction. In addition, with various valuation calculators available over the internet, the process of calculating valuations for fintech startups has become much easier.
In essence, the fintech market has matured and is undergoing a fundamental shift in approach towards valuations. The trend is towards a more practical and balanced approach to valuing startups in order to better predict the future. Therefore, it has become essential for investors to understand the concepts of these valuations and apply the same to fintech startups. This will enable them to accurately value a startup and invest accordingly.
Why use valuation multiples for fintech startups?
The valuation of a startup is an attempt to find an accurate estimate of what the value of the business will be in the future. Valuation is a complex process that involves analyzing multiple factors to form an estimate. Investors use valuation multiples to determine their investment strategy and calculate the fair value of assets. These valuation multipliers are based on historical data and trends and help investors determine whether they should invest in a company or not. Within the fintech industry, there are many multiples that are used to determine the value of a startup.
The process involves determining comparable companies by first identifying similar startups and then evaluating the valuation ratios associated with them. These valuation ratios include a set of comparisons that help investors make an educated judgment about whether a startup is undervalued or overvalued. The approaches used to determine the value of a startup are diverse and may include discounted cash flow (DCF), multiples, P/E ratio, or certain metrics, which are discussed in the next section. However, it is crucial to have a complete understanding of each metric in order to interpret the results correctly. Valuation multiples for fintech startups enable more data-driven decisions for investors and provide a basis for comparison.
Important valuation multiples to use for fintech valuation
Now that you have a basic understanding of the approach to valuing startups, it is worth spending some time understanding the most commonly used multiples used in the fintech industry. Following are some of the most commonly used valuation multiples:
1. Revenue multiple or book value - This valuation method is used to estimate the value of a company based on its revenue figures. This is a popular approach since it is easily derived from financial statements and requires minimal effort. For this type of valuation, both startups and companies are evaluated based on their past revenues. The basic assumption is that if a company is able to achieve stable revenues over time, there will be profits in the future, and an investor can judge the potential of future cash flows by analyzing past performance. It is important to note that the revenue multiple is solely based on a company's revenues and is independent of any other factor.
2. P/E ratio - A P/E ratio is an indicator that is used to measure the price-earnings ratio, i.e., the price per share relative to the company's earnings per share (EPS). It helps investors understand how much they should pay for a stock based on its earnings potential at a particular point in time. In mathematical terms, the P/E ratio is calculated by dividing the share price by the earnings per share. The P/E ratio is an important indicator that helps investors understand a company's value. It helps them decide if they should invest in a startup based on their earnings potential. This is a popular approach adopted by investors across the world.
3. Discounted cash flow - A discounted cash flow is a financial model that attempts to predict the future cash flows of a company. This approach is used to evaluate the value of a company based on future cash flow by discounting them to their current value. This analysis assumes that a company's future growth will be steady and predictable. The discounted cash flow is primarily used for investment decisions that require a dynamic approach. The process uses the cash flow from the previous year to predict the future cash flows along with the discount rate, otherwise known as the interest rate. Simply, it refers to estimating the value of an investment based on future cash flows.
4. EBITDA multiple - The EBITDA refers to earnings before interest, taxes, depreciation, and amortization. While the EBITDA a multiple is a valuation approach that compares a company's enterprise value to its annual EBITDA (either past or forecasted value). This method measures the value of a business and then compares it to the value of other, similar businesses. The EBITDA multiple is a valuation approach that facilitates the comparison of companies across multiple sectors and geographies. This helps simplify the valuation process, which is mostly based on earnings. Corporate financiers often use the EBITDA multiple and professional investors and, therefore, is a preferred method of valuation for startups within the fintech sector.
Important factors to consider in fintech valuation
It is important to keep in mind that a few factors influence the valuation of startups. Given below are some important factors you should consider before making your final decision:
1. Problems and ability to solve - The success of a startup heavily depends on how they solve a problem or offer a solution to an existing set of problems. It is important to keep in mind that a problem or a solution determines the overall value of a company. It is crucial to evaluate customers' pain points, assess the current market landscape, and explore the potential and future implications of spending patterns and customer psychology. A startup's value can be calculated by analyzing and understanding if its business model is able to improve on all these factors.
2. TAM/SAM - The advancement and maturity of technology results in increased scalability of services and adoption by more customers. This allows startups to expand and capture a larger share of the total market. It is important to understand how TAM/SAM affects the overall valuation of a startup. Generally, a startup with a large TAM/SAM indicates that the company has a scale and can capture a significant market share. This can help the company grow and expand, increasing the overall value. In addition, as the company can attract a large number of users, it can increase revenues and market share, further enhancing its valuation.
3. Setup and distribution cost - The setup and distribution cost of a startup depends on the techniques and technologies it uses to reach out to its customers. A company that can reduce distribution costs via cost-effective means can increase its profit margins, which directly impacts the startup's overall valuation. In addition, it allows companies to focus on other important aspects of their business rather than focusing on distribution costs. It is vital to assess the setup and distribution costs of a startup and understand their impact on the overall value of the business.
4. Revenue model - It is crucial to evaluate the revenue model of a startup and understand the factors that affect it. Startups aim to create high market value by capturing a large market share over a short period of time. In this regard, startups primarily focus on high growth in order to generate revenues. This is possible when a startup can target different customer segments or address the market's unmet needs. Therefore, it is important to identify the various revenue streams that can be generated by a startup, which will help you understand its value.
5. Cross-selling - A company's overall value increases if it maintains long-term customer relationships and continues to sell products and services beyond the expected yield. With AI and chatbots in the workplace, it is now possible to anticipate customer needs and provide tailored solutions based on their requirements. Therefore, a startup can increase its overall value by increasing cross-sell rates which can be achieved by offering customized services and solutions. The ability to detect and predict customer needs can help a startup increase its revenue and, therefore, its valuation.
6. New users - As a startup, it is important to engage with new users to create strong relationships and increase the company's value. In regard to the fintech industry, the valuation may fluctuate for some P2P payments and lending startups directly as a result of the number of new users. A proper analysis of the new users is important to understand a startup's overall value.
Key steps to conduct multiple analysis
It is essential for startups to understand the steps involved in conducting a detailed valuation analysis. It is important to keep in mind that proper planning and execution of the financial analysis will help startups to understand its true value.
1. Analyze the financial figures of similar companies in the industry and understand their value. This will help startups understand the financial health of companies in the same sector.
2. It is crucial to convert similar companies' financial numbers into standardized values. Standardized values are easier to understand and compare in order to calculate the overall valuation.
3. Startups should consider applying the same analysis to the company’s key financial metrics. It is important to understand how these metrics impact the company's overall valuation.
Conclusion
Fintech startups are constantly evolving and must be able to adapt to the changing perceptions and preferences of their customers. It is important to understand the different valuation multiples in order to assess their overall value. Detailed financial analysis helps startups to understand their market value and identify areas for growth.
