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Week 5CHAPTER 05Entrepreneurial Finance

Valuation Methods for Startups

The capstone of the valuation sequence, turning the Week 4 forecast into a defensible number across every professional method. Why every valuation answers one question and how the income, market, and cost approaches triangulate; the DCF engine from FCFF and FCFE to enterprise and equity value; building the discount rate with CAPM and WACC (and the circularity problem); terminal value via the Gordon Growth Model and exit multiples; IRR, its hidden reinvestment flaw, and MIRR; stage-adjusted year-by-year discount rates; the market lens of trading comparables and precedent transactions; the VC method and future-dilution math; the cost approach as a floor; how deal terms diverge from headline valuation; probability-weighted scenario value; and triangulating every method into a football-field range, with seven interactive calculators.

Estimated time

140 min

Note sections

30

Practice questions

52

Interactive tools

8

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Learning Objectives

By the end of this chapter you should be able to:

  • 1Explain why valuation ultimately answers one question (what a specific buyer will pay a specific seller at a specific time) and how the income, market, and cost approaches triangulate.
  • 2Build a discounted cash flow valuation from free cash flow, distinguishing FCFF (discounted at WACC to enterprise value) from FCFE (discounted at the cost of equity to equity value).
  • 3Construct a discount rate using the CAPM cost of equity and WACC, add a size premium for small firms, and recognize the circularity problem in WACC.
  • 4Estimate terminal value with the Gordon Growth Model and the exit multiple method, and interpret why terminal value is typically 60 to 80% of enterprise value.
  • 5Compute and compare IRR and MIRR, and explain the reinvestment-rate assumption and the multiple-IRR problem that MIRR resolves.
  • 6Apply stage-adjusted, year-by-year discount rates that decline as venture risk resolves, rather than a single flat rate.
  • 7Value a company with the market approach using trading comparables and precedent transactions, and avoid the common selection pitfalls.
  • 8Apply the VC method to work backward from a projected exit at a target return, and adjust the required ownership for future dilution.
  • 9Use the cost approach as a floor, distinguish valuation from deal economics, and combine probability-weighted scenarios and triangulation into a defensible value range.

Part One: Every Valuation Answers One Question. Section 1 of 8.

Part One · Every Valuation Answers One Question

Every Valuation Answers One Question

Section 1 / 8

Converting an uncertain future into a present-day price

1 min read

Valuation is the act of converting an uncertain future into a present-day price. Every method, model, and back-of-napkin estimate is a version of the same exercise: project what an asset will produce, adjust for risk, and express the result in today's dollars. The differences between methods are differences of inputs, assumptions, and which risks receive explicit treatment versus which get buried in a single number.

The three master approaches

2 min read1 knowledge check

Professional valuators organize their work into three master approaches, codified in the International Valuation Standards (IVS, effective 31 January 2025) and the American Society of Appraisers Business Valuation Standards. The income approach values the business as the present value of expected future cash flows, with DCF as the primary tool. It is central to venture analysis because a venture's value lies almost entirely in future cash flows that do not yet exist. The market approach values the business by reference to what similar businesses have sold for, in public trading markets or completed transactions. It is observational: it tells you what buyers have paid, not what the asset is intrinsically worth. The cost approach values the business at the cost to reproduce or replace its underlying assets, relevant for asset-heavy or distressed businesses and rarely primary for operating companies with intangible value.

Three columns labeled Income, Market, and Cost: income captures future growth, the market grounds value in observed prices, and cost sets a floor, with the three triangulating toward a value range.
Figure 1. Income captures growth, the market grounds it, and cost sets a floor. Professionals use all three and triangulate.
ApproachBest when
Income (DCF, VC method)Future cash flows are the primary source of value; the company is growing or pre-profit
Market (comps, precedents)Sufficient comparable companies exist and you need a market-grounded sanity check
Cost (adjusted net assets)Asset-heavy business, a liquidation scenario, an IP portfolio, or a holding company

For entrepreneurial ventures, the income approach is primary because it captures future growth. The market approach provides a reality check on what investors are actually paying. The cost approach sets a floor, what the business is worth if broken up. Professionals use all three and triangulate.

Where this part breaks down. The three approaches are lenses, not truths. Each buries some risks in a single number, and no single approach is fully objective; the choice of method and inputs shapes the answer more than the framework label.

Check Your Understanding

1

Knowledge Check 1

Valuation & DCF

In valuing an early-stage venture, how do the three master valuation approaches (income, market, and cost) generally fit together?