Arriving at the valuation of an internet startup is considered as an art, which is perhaps the best mask for the cluelessness of an entrepreneur and the generalization done by investors. This labyrinth is a byproduct of varied subjectivity with a large focus on the qualitative rather than quantitative valuation methods like P/E comparable or discounted cash flow methods. The limited data available on comparable companies and industry benchmarks has only contributed towards the complexity. There also exists a significant amount of survivorship bias, which effectively ignores the results of Internet start-ups, which get shutdown. This problem gets further accentuated given the nascency of venture capital (VC) in India.

The off-shoot of this valuation mismatch has been the limited number of investments in seed stage and early stage ventures. Attributing the lack of pathbreaking products like Google, YouTube and Twitter from Indian entrepreneurs due to lack of creativity, would be a huge misnomer. The product development support for such ideas is missing from the Angel and VC fraternity of India. Thus, the divide that has been created, is because the risks of - venture capitalists not aligned with the valuation and capital expectations, of Indian entrepreneurs, who use their silicon valley counterparts as a benchmark.

Financial projections presented by entrepreneurs in India, are generally, a haphazard assortment of perceived expectations, irrational confidence, and market defiance and excel modeling of maybe about 2-3 hours. Therefore, besides the validation of common valuation variables, also significant adjustments have to be made to the valuation, keeping in mind the consumer behavior, Indian Internet industry and the Indian entrepreneur psyche. The value and weights of these adjustments depends on the impact they have on the business model and should be taken on venture to venture basis.

The primary task is to arrive at a base valuation of the start-up, which can be done through either the Terminal value method by Professor William Sahlman or the Probability Adjusted Present Value (PAPV) method. The effectiveness of the PAPV method in the Indian context is impugnable as both the volume of start-up investments and quality data available on them is low. In the terminal value method, usage of arbitrary assumptions for earnings multiple and P/E ratio can result in a value, which is discordant with the true value of the start-up. The P/E ratio of a comparable firm being used should be congruous with the stage of the life cycle of the internet start-up.

Positive Adjustments to the Valuation