Home » Why You Should Not Use the Asset Approach for Start-ups

Why You Should Not Use the Asset Approach for Start-ups

by janeausten

Initially, most start-ups rely on the founders’ personal savings or internal resources. When they are unable to aggregate sufficient finances, they must turn to outside sources. To asset approach external sources for finance, start-ups should first determine the seed amount needed through a business appraisal.

A business valuation is critical for start-ups since it determines how much equity the company should give to an investor in exchange for needed funding. As a result, if the company’s worth is higher, its founders must issue less stock or shares to investors in exchange for their investment.

A start-up valuation is necessary for entrepreneurs, but it is also essential for investors since it helps them determine the amount of return they should receive on their investment.

What exactly is the Asset Approach?

The worth of a company’s assets, or the fair market value of all its assets after subtracting liabilities, is the emphasis of asset-based valuation. The asset strategy is used by companies in the investment sector, such as financial or real estate investors.

It entails reviewing the company’s balance sheet, listing the total assets of the company, and deducting the total liabilities to determine the book value of assets. It also aids in determining the company’s liquidation value after selling all of its assets and clearing all of its liabilities.

The Net Asset Valuation Method, often known as Book Value, computes the total value of assets less total liabilities. It is extremely useful in estimating the worth of petroleum corporations, natural resource companies, real estate enterprises, and other similar entities.

Whereas the asset approach’s Adjusted Net Book Worth Method, or Adjusted Book Value, assists in determining the value of the going concern by adjusting its tangible assets and liabilities to their current fair market values.

What Goes Wrong When Using the Asset Approach to Value a Start-up?

Inadequate assets for valuation

The asset strategy necessitates that the organization calculates all forms of assets, including physical, financial, intellectual property, brand value, customer contracts, and the theoretical salary not given to founders and executives.

Most start-ups, however, lack tangible assets and rely instead on intangible assets such as software, patents, and team abilities, which are difficult to evaluate. Even if the start-up has tangible assets, its worth would be substantially lower in comparison.

In the case of start-ups, analysts should look for the value as a combination of tangible assets and internal elements such as organizational processes, product and service rollout, research and development, and so on. Because the combination generates the prospect of generating money, it contributes to the creation of value.

The asset approach, for example, is worthless when attempting to value a management consulting firm. This is due to the fact that the overall tangible assets constitute a minor portion of the company’s value-creating assets. The company’s value-driving assets are a combination of the team’s talents and intangible assets such as brand, expertise, and client portfolio.

Furthermore, the asset approach to business valuation ignores the company’s potential earnings. When analysts use other valuation methodologies to assess the firm’s earnings potential, the value of the company determined is considerably more reliable than when they use the asset approach.

Uncertainty about the book value of intangible assets.

Another drawback of the asset strategy is the complicated process of valuing intangible assets such as patented technology, domain names, and so on. This is complex because these assets often do not have a book value. As a result, an analyst using the asset technique to value a start-up requires a high level of knowledge, experience, attention to detail, and accuracy. The Discounted Cash Flow Method is better appropriate for new businesses.

When Is the Asset Approach Effective?

The asset approach disregards future potential and predicted cash flow in favor of reflecting the previous cost of establishing the business. Investing in start-ups, on the other hand, is focused on identifying the risks involved with the firm and determining its earning potential.

However, the asset method performs exceptionally well in situations such as:

Asset-Heavy Enterprises

Companies where the assets themselves are the primary revenue generator, such as real estate companies overseeing the purchasing and selling of properties, are ideal candidates for the asset strategy.

To value such a company, analysts might use the asset approach to add the book value of the assets on the balance sheet.

You may also like this article: A Complete Guide on Business Valuation Asset Based Approach

Business Under Liquidation

If the company is due to discontinue operations and the assets combined are insufficient to generate operating revenues, it can be appraised using the asset approach.

The purpose here is to understand the asset sales value rather than the firm as a continuing concern.

How Different Is a Start-Up Valuation?

Start-up valuation processes and methods aid in calculating the value of a new business. Business owners want a high valuation at the pre-revenue stage, but investors prefer a lower valuation that guarantees a larger return on investment.

Analysts must analyze a variety of factors, including the management team and industry trends, as well as the demand for the company’s products and services and the associated marketing risks.

A start-up, unlike a mature, publicly traded firm, lacks a consistent stream of income and financial records, such as earnings before interest, taxes, depreciation, and amortization, which generally aid in the valuation process.

The asset approach evaluates the start-up in its current condition rather than how it will be in the future. Investors are more interested in the latter, and because asset-based valuation does not account for this, it has some limits.

It is difficult to calculate an appropriate value while the project is in its early phases because there is so much ambiguity about its success or failure. However, there are other approaches to determining the worth of a start-up. Even if the asset-based appraisal is one of the ways, it is ineffective.

Factors Influencing a Start-up’s Valuation Asset Approach

To determine the worth of a start-up, analysts must analyze elements such as the success of marketing activities and the rate of growth. They must also acknowledge the value of the founders’ prior experience, diversity of abilities, and devotion and commitment to the start-up.

A workable model, a Minimum Viable Product (MVP), and early adopters assist start-ups in attracting early funding. If the company uses the valuation-by-stage strategy, which many venture capitalists and angel investors utilize, it may pool additional funds.

The market in which the start-up operates has an impact on its valuation as well. A competitive market with several companies in comparable businesses, for example, diminishes the value of a start-up. A business with a unique and trending idea, on the other hand, is far more valuable.

In a flourishing industry, such as mobile gaming or artificial intelligence, where investors are willing to pay a premium, a start-up can be worth more. Furthermore, if the start-up delivers excellent margins and expectations of significant revenue growth, it can attract larger financing.

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Concluding Thoughts

Getting professional assistance and determining a more realistic business value might assist start-ups in negotiating better investment packages. Aside from the asset strategy, numerous other ways can be used to evaluate a start-up more effectively and properly.

The asset-based approach, like any other valuation method, has advantages and disadvantages. Entrepreneurs or start-up founders must hire the right personnel with the necessary experience and expertise to evaluate and determine the business worth of their new venture.

The stage of the start-up also influences the method that can best estimate its business worth. The objective of a company’s valuation varies depending on its age.

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