HUGE LOSSES BUT HIGH VALUATION, WHY AND HOW?
Companies, particularly startups, are sometimes regarded as unicorns even while they are making losses. This may seem odd, but even some of the well-established firms are not valued as high as some startups, and in certain situations, these well-established companies are valued well below their true worth.
Now the question arises, Why is this happening? Well valuing a loss-making company can be a seriously tricky affair. It is even more difficult to value a company with negative earnings than a company with positive earnings. There are many reasons behind this strange valuation like discounted cash flow, future expectations, and forward-looking projections.
In cases where you see big hi-tech companies undertaking IPOs at eye-watering amounts, even though they aren't in profits, they are essentially creating a large pool of investment to take the company forward to achieving its next level. Investors go for this situation because they perceive that the heavy risk of a start-up has already been borne by the founder shareholders, so the new investment will be the additional money needed to realize actual profitability. Valuation isn't a "balance sheet", it's an expectation for the future, what the business is expected to be worth 2, 3, 6 years down the road. 90% of the "money" in the world we live in, is a bet on the future. Literally, the bank you hold your money in is legally required to have approximately 5% of the holdings it reports. The rest (95%) is all bet on the future. Thus, if a company is making a loss for the purpose of growth and expansion, its value is higher than its balance statement.
Valuation is all about stories and opinions on the companies. Every firm's management conveys their firm's story to the investor community, some buy it and some don't. The one who buys the story defines the value of a company. All you need is a reasonable basis to back your projections. And that's what any start-up founder tries to do to raise money.
Now going into technical aspects of it, there are valuation metrics that any firm can use to define a comparison between their start-up firm and an already established related firm. These valuation metrics vary from industry to industry but the most basic ones are price to sales or revenue ratio. For eg- an E-commerce startup can use the relevant ratios of already listed e-commerce companies like Amazon, Alibaba, etc, and based on geography, a certain risk premium is added along with the discount for being a startup firm and then the value is derived based on negotiations and that value doesn't have to be the perfect one as far as some person is buying your story. There are many other factors considered while doing business or income valuation like History, ROI, Dominance, Cost of liquidation, Leverage, Minority Interest, Terms of sale, etc.
Accordingly, StartUps in India are throwing their money into selling their goods at much lesser prices i.e higher discounts than what can be bought in the retail stores, for example, Zomato, Swiggy, Ola, Uber, etc. This is possible because of the investments they receive. And they follow the circular process i.e- The more customers you have, the more people are interested to invest in your company, And the more investment you have the more capital is with you, and hence the more discounts you can give on your goods, the more customers you gather. Hence one could value a startup with no or minimal revenue by estimating revenue streams, say achieving x% of a known marketplace. The VCs then calculate valuations based on industry multiples for similar companies in the public markets. VCs tend to have particular outlooks and long-term horizons so they will value things differently than most investors; additionally, negotiated funding terms often have provisions like liquidation preferences that have significant value but aren't reflected in the "valuation" as a single number.
Therefore, put all this together and you get a good picture of why the valuation of a company is not determined solely by its revenue, and why companies without significant revenues can still have high valuations.
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