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8 Startup Valuation Methods: Each Method Explained

Startup Estimation
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Understanding the worth of a startup is a complex task, with many factors contributing to its value. This comprehensive guide will unpack the different startup valuation methods, offering a detailed explanation of each method.

The Essence of Startup Valuation

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Startup valuation refers to the process of determining the economic worth of a startup company. New ventures, which are typically characterized by their innovative ideas or technologies, need to have a clear understanding of their worth for various reasons.

Investors require this information to ascertain the potential return on their investment, while the internal stakeholders within the startup need it for strategic planning and resource allocation. However, assigning a value to a startup is a challenging task due to factors such as lack of historical financial information, uncertain future performance, the absence of comparables, reliance on funding rounds, and the influence of subjectivity and biases.

Eight Common Startup Valuation Methods

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Let’s delve into the eight most common startup valuation methods, which range from the Berkus Method to the Book Value Method.

1. The Berkus Method

The Berkus Method is one of the valuation methods often used to evaluate early-stage startups. It was developed by Dave Berkus, an experienced angel investor, as a way to assess the potential value of startups, especially when traditional financial data is limited. This method provides a structured approach to considering various aspects of a startup’s potential, allowing investors and entrepreneurs to make more informed decisions.

Key Components of the Berkus Method:

  1. Sound Idea (Up to $500,000): In this component, the valuation considers the strength and viability of the startup’s core idea. Investors assess whether the concept has the potential to address a significant problem or need in the market. A well-defined and promising idea can contribute significantly to the startup’s valuation.
  2. Prototype (Up to $1 Million): If the startup has developed a prototype or a working model of its product or service, this adds value to the valuation. The quality of the prototype, its functionality, and how close it is to a market-ready product are all factors considered here. A more advanced prototype can increase the valuation.
  3. Quality Management Team (Up to $1 Million): The startup’s management team plays a crucial role in its success. Investors assess the team’s experience, skills, and track record. A capable and experienced team can command a higher valuation as they are better equipped to execute the business plan effectively.
  4. Strategic Relationships (Up to $1 Million): Partnerships and strategic relationships with other companies or organizations can enhance a startup’s value. These relationships may include joint ventures, licensing agreements, or collaborations that provide access to resources, distribution channels, or markets.
  5. Product Rollout or Sales (Up to $1 Million): Progress in bringing the product or service to market can positively impact valuation. Investors look at factors like initial sales, customer adoption rates, or letters of intent from potential customers. Successful sales efforts demonstrate market demand and revenue potential.

Advantages of the Berkus Method:

  • Simplicity: The Berkus Method is relatively straightforward to apply, making it accessible to both investors and entrepreneurs, especially in early-stage scenarios.
  • Focus on Key Factors: It emphasizes critical factors that contribute to a startup’s success, such as the strength of the idea, the team, and progress in product development.
  • Qualitative Assessment: Unlike purely financial methods, the Berkus Method considers qualitative aspects that are often more relevant in the early stages of a startup.

Limitations of the Berkus Method:

  • Subjectivity: The valuation is subject to the judgment of the investor, which can lead to variations in valuation outcomes.
  • Limited Precision: The method provides only a rough estimate of a startup’s value and may not be suitable for more mature businesses with established financial data.
  • Potential for Bias: Investors may have different opinions on the value of the components, leading to potential bias in the valuation.

The Berkus Method serves as a valuable tool for assessing early-stage startups, offering a structured approach to evaluating their potential. While it may not provide a precise valuation figure, it helps investors and entrepreneurs consider the critical elements that contribute to a startup’s success. It’s often used in conjunction with other valuation methods to arrive at a more comprehensive assessment of a startup’s value.

2. Comparable Transactions Method

The Comparable Transactions Method, also known as the Market Approach, is a common valuation method used to assess the value of a startup by comparing it to similar businesses that have been sold or valued recently. This method relies on the idea that the market provides valuable insights into a company’s worth by examining transactions involving similar companies.

Key Steps in the Comparable Transactions Method:

  1. Identify Comparable Transactions: The first step is to identify recent transactions involving startups or businesses similar to the one being valued. These transactions should ideally be in the same industry, of similar size, and have comparable characteristics.
  2. Gather Data: Collect detailed information about the comparable transactions, including the sale price, financial metrics, industry trends, and any unique factors that influenced the valuation.
  3. Adjust for Differences: Since no two businesses are identical, it’s essential to adjust the data from comparable transactions to account for differences between them and the startup being valued. Common adjustments include factors like size, growth rate, market conditions, and risk.
  4. Calculate Valuation Metrics: Use valuation multiples or ratios derived from the comparable transactions to estimate the startup’s value. Common multiples include Price-to-Earnings (P/E), Price-to-Sales (P/S), and Enterprise Value-to-EBITDA (EV/EBITDA).
  5. Apply the Multiple: Multiply the relevant valuation multiple by a financial metric of the startup, such as its earnings, revenue, or EBITDA, to arrive at an estimated value.

Advantages of the Comparable Transactions Method:

  • Market-Based: This method relies on real-market data, making it relevant and reflective of current industry conditions.
  • Intuitive: It is relatively easy to understand and explain, making it accessible to investors and stakeholders.
  • Considers Market Sentiment: Reflects market sentiment and investor perceptions, which can be valuable in dynamic industries.

Limitations of the Comparable Transactions Method:

  • Limited Data: Finding truly comparable transactions can be challenging, especially for startups with unique characteristics.
  • Data Quality: The accuracy and completeness of data about comparable transactions can vary, leading to potential inaccuracies in the valuation.
  • Subjectivity: Adjustments for differences between the comparable transactions and the startup being valued can be subjective and may vary between analysts.
  • Market Fluctuations: Valuations based on recent transactions may not capture longer-term market trends or anticipate future changes.

The Comparable Transactions Method provides valuable insights into a startup’s value by benchmarking it against real-world transactions. However, it should be used in conjunction with other methods and considered within the broader context of the startup’s unique characteristics and growth potential.

3. Scorecard Valuation Method

The Scorecard Valuation Method is an approach used to assess the value of early-stage startups by assigning scores to various factors that contribute to a company’s potential success. It provides a structured framework for angel investors and venture capitalists to evaluate startups based on both quantitative and qualitative criteria.

Key Components of the Scorecard Valuation Method:

  1. Market Opportunity (25 points): This factor assesses the attractiveness of the market the startup operates in. It considers the size of the target market, growth trends, and the startup’s potential to capture market share.
  2. Product/Service (20 points): The quality and uniqueness of the startup’s product or service are evaluated in this category. Factors such as innovation, competitive advantages, and scalability are considered.
  3. Management Team (25 points): The experience, skills, and track record of the startup’s management team play a crucial role in its success. Investors assess the team’s ability to execute the business plan effectively.
  4. Traction and Milestones (15 points): This component examines the startup’s progress in terms of customer acquisition, revenue generation, product development, or achieving key milestones. Evidence of traction can positively impact the valuation.
  5. Revenue Model (15 points): The sustainability and scalability of the startup’s revenue model are evaluated. Investors consider factors like pricing strategy, customer acquisition costs, and revenue projections.

Scoring and Valuation Calculation:

Each of the five components is assigned a maximum score of 25 points, adding up to a total score of 100 points. Investors assign scores to each factor based on their assessment of the startup. The higher the score, the more valuable the startup is considered.

The valuation is calculated by multiplying the total score by a predetermined valuation factor, typically ranging from $50,000 to $200,000 per point. The valuation factor is determined based on market conditions and investor preferences.

Advantages of the Scorecard Valuation Method:

  • Structured Assessment: Provides a structured framework for evaluating startups, making the process more systematic and transparent.
  • Focus on Key Factors: Emphasizes critical factors such as market opportunity, the strength of the team, and product quality.
  • Customizable: Allows investors to adjust scoring criteria and weights based on their investment preferences.

Limitations of the Scorecard Valuation Method:

  • Subjectivity: The scoring process is subject to the investor’s judgment and may vary among investors.
  • Simplified Model: While it provides a structured approach, it may oversimplify the valuation process for more complex startups.
  • Market Dependency: The valuation factor is influenced by market conditions, which can lead to variations in valuations.

The Scorecard Valuation Method is a valuable tool for assessing early-stage startups, offering a systematic way to consider critical factors that contribute to their potential success. It provides a framework for investors to make informed decisions while considering both quantitative and qualitative aspects. However, it should be used in conjunction with other valuation methods for a comprehensive assessment of a startup’s value.

4. Cost-to-Duplicate Approach

The Cost-to-Duplicate Approach, also known as the Asset-Based Approach, is a startup valuation method that focuses on assessing the value of a startup’s tangible and intangible assets. It provides an estimation of the value required to recreate or duplicate the startup’s assets, including technology, intellectual property, and physical resources.

Key Components of the Cost-to-Duplicate Approach:

  1. Tangible Assets: This component includes the physical assets owned by the startup, such as equipment, machinery, office space, and inventory. The valuation considers the current market value of these assets.
  2. Intangible Assets: Intangible assets encompass intellectual property, patents, trademarks, copyrights, proprietary technology, and brand reputation. The value of these assets is assessed based on their market worth or potential licensing or sale value.
  3. Development Costs: The expenses incurred in research, development, and product or service creation are taken into account. These costs reflect the investment made in bringing the startup’s offerings to market.
  4. Liabilities: Liabilities, such as outstanding debts or obligations, are deducted from the total asset value to arrive at the net asset value.

Calculation and Valuation:

The valuation in the Cost-to-Duplicate Approach is calculated by summing the values of tangible assets, intangible assets, and development costs while subtracting any liabilities. The resulting net asset value represents the estimated cost required to duplicate the startup’s asset base.

Advantages of the Cost-to-Duplicate Approach:

  • Asset-Centric: It provides a clear valuation based on the tangible and intangible assets, making it suitable for asset-heavy startups.
  • Objective: The valuation relies on the market value of assets, which can be determined objectively.
  • Useful for Asset Sale: If the startup’s primary exit strategy is to sell its assets, this approach provides a relevant valuation framework.

Limitations of the Cost-to-Duplicate Approach:

  • Ignores Earnings and Cash Flow: It does not consider the startup’s future earnings potential or cash flow, which may undervalue startups with high growth prospects.
  • Intangible Asset Valuation Challenges: Determining the market value of intangible assets can be complex and subjective.
  • Limited for Service-Based Startups: This approach may not be suitable for startups that primarily offer services without significant tangible assets.

The Cost-to-Duplicate Approach is particularly useful for startups with substantial tangible and intangible assets that play a significant role in their value proposition. However, it should be used alongside other methods to provide a comprehensive view of a startup’s overall value, especially when considering its growth potential and future earnings.

5. Risk Factor Summation Method

The Risk Factor Summation Method is a startup valuation approach that assesses the various risks associated with a startup’s business and translates them into a numerical score. This method allows investors to quantify the level of risk inherent in the startup and adjust the valuation accordingly. It is a valuable tool for considering both quantitative and qualitative risk factors.

Key Components of the Risk Factor Summation Method:

  1. Market Risk: This factor evaluates the level of risk associated with the startup’s target market. Considerations include market size, competition, and potential market disruptions. A more competitive or volatile market may lead to higher risk scores.
  2. Technology Risk: Assess the level of risk related to the startup’s technology or product development. Factors include technological complexity, intellectual property protection, and the maturity of the technology. High technological uncertainty can result in increased risk scores.
  3. Team Risk: The competence and experience of the startup’s management team are crucial. Evaluate factors such as team cohesion, industry expertise, and previous successes. Inexperienced or unproven teams may receive higher risk scores.
  4. Financial Risk: Consider the startup’s financial stability and sustainability. Factors include cash flow, funding sources, and revenue projections. A lack of financial stability may contribute to higher risk scores.
  5. Regulatory Risk: Assess the level of regulatory or compliance risk the startup faces. Factors include industry regulations, legal challenges, and potential changes in regulations. Highly regulated industries may receive higher risk scores.
  6. Competition Risk: Evaluate the competitive landscape and the startup’s ability to differentiate itself. Factors include market share, barriers to entry, and competitive advantages. Intense competition or lack of differentiation may lead to higher risk scores.
  7. Sales and Marketing Risk: Consider the startup’s ability to reach and acquire customers. Factors include marketing strategies, customer acquisition costs, and sales channels. Ineffective marketing or high customer acquisition costs may result in higher risk scores.

Scoring and Valuation Calculation:

Each risk factor is assigned a score based on its perceived level of risk, typically on a scale of 1 to 5 or 1 to 10, with higher scores indicating higher risk. The scores for all risk factors are then summed to calculate the total risk score.

The valuation adjustment is determined based on the total risk score. The higher the risk score, the greater the downward adjustment applied to the startup’s valuation. Conversely, lower risk scores result in less significant valuation adjustments.

Advantages of the Risk Factor Summation Method:

  • Comprehensive Risk Assessment: It provides a structured approach to evaluating and quantifying various risk factors, offering a comprehensive risk assessment.
  • Customizable: Investors can customize the risk factors and scoring criteria based on their preferences and the specific industry or startup characteristics.
  • Alignment with Risk Tolerance: The method allows investors to align the valuation with their risk tolerance and risk-reward preferences.

Limitations of the Risk Factor Summation Method:

  • Subjectivity: Assigning scores to risk factors can be subjective and may vary among investors.
  • Lack of Precision: While it quantifies risk, it does not provide a precise valuation figure and should be used in conjunction with other methods.
  • Potential for Bias: Investors may have different perceptions of risk, leading to variations in valuation outcomes.

The Risk Factor Summation Method offers a valuable approach to assessing startup valuations by explicitly considering the level of risk associated with the business. It helps investors make informed decisions while accounting for both quantitative and qualitative risk factors. However, it should be used as part of a comprehensive valuation strategy, considering other factors like growth potential and market conditions

6. Discounted Cash Flow Method

The Discounted Cash Flow (DCF) Method is a widely used valuation approach that assesses the present value of a startup by estimating its future cash flows. This method is particularly valuable for startups with a clear and reliable projection of future cash flows.

Key Steps in the Discounted Cash Flow Method:

  1. Cash Flow Projections: The first step involves forecasting the startup’s future cash flows. These projections typically cover several years and should include revenues, operating expenses, and capital expenditures.
  2. Determining the Discount Rate: The discount rate, often referred to as the “required rate of return,” is a critical factor in DCF valuation. It represents the rate of return that an investor expects to receive to justify the investment’s risk. It considers factors such as the startup’s risk profile, market conditions, and the opportunity cost of capital.
  3. Discounting Cash Flows: Future cash flows are discounted back to their present value using the determined discount rate. This step involves applying the time value of money principle, as cash received in the future is considered less valuable than cash received today.
  4. Terminal Value: To account for cash flows beyond the forecast period, a terminal value is calculated. This represents the value of the startup at the end of the projection period and is often determined using methods like the perpetuity growth model or the exit multiple method.
  5. Summing Present Values: The present values of both the projected cash flows and the terminal value are summed to arrive at the total enterprise value of the startup.
  6. Equity Valuation: To determine the equity value (what the startup is worth to its equity investors), any outstanding debt and other liabilities are subtracted from the enterprise value.

Advantages of the Discounted Cash Flow Method:

  • Focus on Cash Flows: It provides a detailed analysis of the startup’s expected cash flows, making it suitable for businesses with predictable revenue streams.
  • Consideration of Risk: The discount rate accounts for the startup’s risk profile, offering a customized valuation based on perceived risk.
  • Flexibility: The DCF method can be applied to startups at various stages, from early-stage to mature companies, provided reliable cash flow projections are available.

Limitations of the Discounted Cash Flow Method:

  • Reliability of Projections: The accuracy of the valuation heavily depends on the quality and accuracy of the cash flow projections, which can be challenging for startups with limited operating history.
  • Sensitivity to Assumptions: Small changes in assumptions, such as growth rates or discount rates, can lead to significant variations in valuation outcomes.
  • Lack of Market Data: The method relies on internally generated cash flow projections and may not consider market dynamics or comparable transactions.

The Discounted Cash Flow Method is a robust approach to valuing startups that relies on the estimation of future cash flows. It is particularly valuable when there is confidence in the accuracy of cash flow projections and when the startup’s risk profile can be accurately assessed. However, it should be used with caution, considering the sensitivity of the valuation to assumptions and the availability of reliable data.

7. Venture Capital Method

The Venture Capital Method is a startup valuation approach commonly used by venture capitalists and angel investors to estimate the potential return on investment (ROI) based on the startup’s expected exit value. This method is well-suited for startups seeking external funding and planning for eventual exits through acquisitions or initial public offerings (IPOs).

Key Steps in the Venture Capital Method:

  1. Estimate Terminal Value: The first step involves estimating the expected terminal value of the startup at the time of exit. This is typically based on a projected exit year and a target exit multiple (e.g., revenue multiple or earnings multiple). The terminal value represents the expected value of the startup when it is sold or goes public.
  2. Determine the Required ROI: Investors specify their desired return on investment (ROI) for the startup. This ROI reflects the investor’s expected risk-adjusted return and may vary depending on the startup’s perceived riskiness.
  3. Calculate the Pre-Money Valuation: The pre-money valuation is calculated by subtracting the expected exit value (terminal value) divided by the investor’s required ROI from the post-money valuation. The post-money valuation is the estimated value of the startup at the time of investment.
  4. Investment Amount and Ownership Percentage: Based on the pre-money valuation and the amount of investment sought by the startup, the investor determines the ownership percentage they will receive in exchange for their investment.

Advantages of the Venture Capital Method:

  • Focus on Exit Potential: It emphasizes the potential exit value of the startup, aligning with the objectives of investors seeking high returns.
  • ROI-Centric: This method allows investors to quantify their expected ROI and assess whether the investment aligns with their financial goals.
  • Alignment with Investor Goals: It aligns the startup’s valuation with the desired ROI of investors, making it a suitable approach for venture capitalists and angel investors.

Limitations of the Venture Capital Method:

  • Exit Assumptions: The method heavily relies on assumptions about the startup’s future exit, which can be uncertain and subject to change.
  • Risk Assessment: Estimating the required ROI accurately requires a comprehensive assessment of the startup’s risk profile, which can be challenging.
  • Sensitivity to Assumptions: Like other valuation methods, the Venture Capital Method is sensitive to the choice of exit multiples and the accuracy of projections.
  • Limited Applicability: It is most relevant for startups seeking external funding and planning for specific exit strategies.

The Venture Capital Method provides a framework for aligning startup valuations with the expected returns of investors, particularly those looking for substantial ROI through exits. However, it is essential to consider the uncertainties surrounding exit assumptions and the startup’s risk profile when using this approach.

8. Book Value Method

The Book Value Method is a straightforward approach to valuing a startup based on its accounting book value, which represents the net asset value of the company. This method is relatively simple and is often used for startups with a strong focus on tangible assets.

Key Components of the Book Value Method:

  1. Tangible Assets: The book value primarily considers the startup’s tangible assets, including equipment, machinery, inventory, and real estate. These assets are recorded on the company’s balance sheet at their historical cost minus depreciation.
  2. Intangible Assets: While the method primarily focuses on tangible assets, it may also consider certain intangible assets like patents, trademarks, or copyrights if they are recorded on the balance sheet at a specific value.
  3. Liabilities: The method deducts all liabilities, including outstanding debts and obligations, from the total asset value to arrive at the net book value.

Calculation and Valuation:

The valuation in the Book Value Method is relatively straightforward. It involves subtracting the total liabilities from the total assets, resulting in the net book value. This net book value represents the estimated value of the startup based on its recorded assets and liabilities.

Advantages of the Book Value Method:

  • Simplicity: It is a straightforward method that relies on readily available financial statements.
  • Objective: The valuation is based on the startup’s accounting records, which are typically objective and verifiable.
  • Asset-Centric: Suitable for startups with significant tangible assets, such as manufacturing or real estate companies.

Limitations of the Book Value Method:

  • Limited for Intangible Assets: It may not capture the full value of intangible assets, such as intellectual property or brand reputation, which can be significant for some startups.
  • Ignores Future Earnings: The method does not consider the startup’s future earning potential, which can result in undervaluation for high-growth startups.
  • Market Conditions: The recorded book value may not reflect the current market value of assets and may not consider market dynamics.
  • Subject to Depreciation: Tangible assets are recorded at their historical cost minus depreciation, which may not reflect their current market value.

The Book Value Method is a simple and objective approach to valuing startups based on their accounting book value. It is most suitable for startups with significant tangible assets and may not fully capture the value of intangible assets or consider future earnings potential. Investors often use this method in conjunction with other valuation approaches to obtain a more comprehensive view of a startup’s value.

Bringing It All Together

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Valuing a startup is both an art and a science. No single startup valuation method is accurate all the time. You’ll likely use multiple methods and combine techniques to find a fair value. The key is understanding these methods and how they can be applied to your startup. The process may involve a little guesswork, but with the right tools and knowledge, you can prepare for future fundraising talks and develop a long-term capital raising strategy.

Valuation by Stage

The valuation of a startup can also be determined based on its stage of development. This approach, often used by angel investors and venture capital firms, assigns a rough value range to the startup, depending on its stage of commercial development. The further along the development pathway the company is, the lower its risk and the higher its value.

The Bottom Line

While valuing a startup is a complex task, understanding the various methods can help provide clarity. Remember, the value of a startup is not just about its current financial performance but also its future potential. By carefully applying these startup valuation methods, you can gain a clearer understanding of your startup’s worth and plan for its prosperous future.

Frequently Asked Questions

1. What are 3 ways to value a startup?

There are several methods to value a startup, but three common approaches include:

  • Market Approach: This method assesses the startup’s value by comparing it to similar companies in the market. It includes methods like the Comparable Company Analysis (CCA) and the Comparable Transactions Analysis (CTA).
  • Income Approach: This approach estimates the startup’s value based on its expected future cash flows or earnings. The Discounted Cash Flow (DCF) method is a notable example of the income approach.
  • Asset Approach: The asset-based approach values the startup based on its tangible and intangible assets. The Book Value Method and the Cost-to-Duplicate Approach are examples of this approach.

2. How do you calculate the valuation of a startup?

The valuation of a startup can be calculated using various methods, but the most common approach is to consider its financial data, growth projections, and risk factors. The Discounted Cash Flow (DCF) method involves estimating future cash flows and applying a discount rate to calculate the present value. Additionally, methods like the Venture Capital Method and Market Approach can also be used depending on the startup’s characteristics.

3. What are the 5 methods of company valuation?

The five common methods of company valuation are:

  • Market Approach: This method uses market data from similar companies to determine the value.
  • Income Approach: It estimates the value based on expected future cash flows or earnings.
  • Asset Approach: This approach values the company’s assets, both tangible and intangible.
  • Venture Capital Method: Primarily used for startups, it assesses ROI based on expected exit values.
  • Book Value Method: It values the company based on its accounting book value.

4. What is a reasonable valuation for a startup?

A reasonable valuation for a startup depends on several factors, including its industry, growth potential, market conditions, and risk profile. There is no one-size-fits-all answer. Investors and founders often negotiate valuations based on their perceptions of the startup’s worth, considering these factors.

5. How much is a business worth with $1 million in sales?

The value of a business with $1 million in sales can vary widely depending on its profitability, growth prospects, industry, and other factors. Typically, businesses are valued based on a multiple of their earnings (e.g., Earnings Before Interest, Taxes, Depreciation, and Amortization – EBITDA). Valuations can range from a few times earnings for small businesses to higher multiples for high-growth companies.

6. How do you value a startup company with no revenue?

Valuing a startup with no revenue can be challenging. Investors often look at other factors, such as the team’s expertise, the uniqueness of the product or service, market demand, and growth potential. Methods like the Venture Capital Method or the Market Approach may be used, focusing on future expectations rather than current revenue.

7. How much is a $100 million revenue company worth?

The value of a $100 million revenue company depends on its profitability, growth rate, industry, and market conditions. A common method is to use a multiple of earnings, such as EBITDA, to estimate its value. For example, a company with $100 million in revenue and strong profitability may be valued at several times its earnings.

8. How much is a business worth with $200k in sales?

The value of a business with $200k in sales will vary based on factors like profitability, industry, growth potential, and market conditions. Small businesses with lower sales figures may be valued at a multiple of earnings, and the specific multiple can vary widely depending on the circumstances.

9. How does Shark Tank calculate valuation?

On the TV show Shark Tank, valuations are often determined through negotiations between entrepreneurs and the “sharks” (investors). Entrepreneurs typically present their valuations based on their perception of their company’s worth, considering factors like sales, growth, and market potential. The sharks then negotiate with the entrepreneurs to agree on a valuation that both parties find acceptable. It’s a combination of art and negotiation rather than a strict financial calculation.

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