NEW YORK (TheStreet) -- How should we value early stage start-up companies?
With some thinking that a new tech bubble is brewing, it's an important question these days.
And it's a tough one to answer. Valuing early stage companies is a combination of "going with your gut" and carefully examining both the current focus and future plans of the business. Many of these companies don't have the metrics to run a proper discounted cash flow analysis or any other type of qualitative evaluation.
Our formula for valuation is more of an art than a science, but it's rooted in logic. Here's what you need to know:
The first thing we look at is how much capital a start-up needs to accomplish their 12-to-18 month goals. Start-ups generally need a lot of funding throughout the course of their lives, but angel or early stage investor are mostly concerned with getting them to the next level, so it's important to define what the next level is.
If you're investing in a social app, then user growth is generally the metric to score. If the company provides software as a service, then revenue may be more relevant. However that next level is defined, that's the goal the company is going to need to hit in order to raise additional capital in the future -- hopefully from top tier venture capitalists. Once you've outlined what progress looks like, it's time to be honest about the capital requirements to get there.