What's Your Company Worth? Ask an Algorithm.
Darius Monsef patiently responded to dozens of questions and wondered whether he was wasting his time. For months, he had tried to come up with a reasonable valuation for his start-up, Colourlovers, a Web community for designers that's based in Portland, Oregon. Could it really be as easy as filling out an online questionnaire?
By the time he was done, he still wasn't entirely sure. But he was happy nonetheless. His company, which will book just $75,000 in revenue this year, was apparently worth $11 million. "It was flattering," Monsef says. "I've figured we're worth maybe a couple million dollars, but maybe I'm selling myself short."
Still, Monsef refrained from breaking out the champagne. After all, the appraisal included few questions covering traditional valuation metrics such as market size, competitive landscape, revenue, or profitability. And it hadn't been performed by a venture capitalist, an accountant, or any other type of professional. It was done by a controversial computer program, the Startup Predictor, offered by a San Francisco -- based company called YouNoodle, which runs an online community focused on start-ups.
YouNoodle's promise is both tantalizing and a little crazy: The company claims it can quantify the traits that make for a successful entrepreneur -- such as education, work habits, and experience -- to predict how much that person's company will be worth three years from its founding. Log on to YouNoodle's website and answer a detailed set of questions, and the program spits out a predicted valuation and a number from 1 to 1,000 that resembles a credit score. (Colourlovers's score was 320.) The test consists of 70 to 100 personal questions, mostly focused on the relationships among founders, advisers, and employees. Entrepreneurs are also asked about their past salaries, work habits, and work experience.
YouNoodle's CEO, Bob Goodson, 28, says the company's goal is to break down the "old boys' club" of top-tier venture capital investors. He imagines that founders outside of traditional venture capital networks -- that is, people who live in the middle of the country and didn't go to one of a handful of top schools -- will eventually be able to take the test and earn meetings with investors on the strength of their YouNoodle scores. Investors, he says, will pay for access to the reports in the same way that used-car buyers pay for a vehicle history report from services like Carfax. "We want to build a Moody's for the start-up world," Goodson says.
Goodson is not new to the world of Internet start-ups. In 2004, he dropped out of Oxford University, where he was studying for a master's degree in medieval literature and philosophy. He soon went to work at Yelp, the website that publishes user-generated reviews of restaurants and service providers, and in 2007, he left to launch You-Noodle. He and his co-founder, an Oxford-trained math whiz named Kirill Makharinsky, teamed up with Rebecca Hwang, a Stanford Ph.D. candidate in social network theory. They collected data on 3,000 companies by interviewing venture capitalists and reviewing academic research, looking for factors that seemed to predict success.
They say they found a number of things that investors tend to overlook. For instance, although VCs typically focus mostly on a founder's background, the backgrounds of employees and even part-time advisers matter a lot, too. Another finding: Founding CEOs trained at Northwestern University tend to create more valuable companies than those who went to more glamorous schools such as Stanford or MIT.
Can an algorithm predict which start-ups will succeed? Max Levchin and Peter Thiel, the co-founders of PayPal, seem to think so; they invested in YouNoodle in late 2007, and so did Thiel's venture capital firm, Founders Fund. But most VCs, who get paid huge management fees to do what YouNoodle purports to do for free, are skeptical, to say the least. "This is a publicity stunt," says Naval Ravikant, a former VC and co-founder of Venture Hacks, a website that advises entrepreneurs in their dealings with investors. "If this worked, VCs would use personality tests and resumés. We can't measure an entrepreneur's spirit or determination online."
Entrepreneurs, on the other hand, have been willing to take YouNoodle's valuation tool for a spin. Some 6,000 have taken the test since it debuted this summer, and the responses have been positive -- perhaps because the algorithm seems to dole out multimillion-dollar valuations rather liberally.
Monsef was drawn to the site out of frustration. He hopes to raise at least $300,000 for Colourlovers and wanted a credible starting point for valuation negotiations with investors. Before turning to YouNoodle, he considered several rule-of-thumb techniques for determining a company's value. He could multiply his revenue by three and get a valuation of $225,000. Or he could assume that each of his one million monthly users was worth $50 -- which isn't unheard of for a fast-growing Web company -- and come up with a valuation of $50 million. "There was a huge range," says Monsef. The $11 million valuation YouNoodle offered him seemed optimistic, but he intends to use it in the business plan he passes out to investors. "As more people use YouNoodle and it gets better, I think it will become standard," he says.
Others are more dubious. Inc. asked two investors, a VC and an angel, to look at Monsef's business plan and come up with their own valuations. Richard Wong, of Accel Partners, a Palo Alto, California, venture capital firm with $4 billion under management, said he would probably peg Colourlovers's valuation at $2 million to $5 million. David Cohen, the executive director of TechStars, a Boulder, Colorado-based angel fund, estimated that the company is worth $1.5 million to $2.5 million.
But both investors cautioned that start-up valuations amount to little more than educated guesses. "I don't think YouNoodle is a bad idea as a tool to play with, but the honest reality is that there's a lot of subjective art to figuring out what a start-up is worth," says Wong. "It's like trying to draft an NBA player out of junior high school."
And yet, though many VCs say YouNoodle seems like a long shot, they concede that making valuations simpler would be a very good thing. "I am not optimistic that they'll be able to nail this," says Fred Wilson, a partner with New York City-based Union Square Ventures. "Nonetheless, it's great that they are trying. The VC market needs more data, more transparency, and more services for entrepreneurs."
Goodson plans to keep tabs on Monsef and the others to see how things turn out and to tweak the algorithm by cutting out questions that seem irrelevant or adding incisive new ones. As to resistance on the part of VCs, he says the reaction is inevitable. "Whenever you have humans making decisions and computers come along, there's always skepticism," Goodson says. "We think the venture capital industry is too important to the future of the economy to be left to the old ways."
For more on determining a company's worth, check out our annual valuation guide. Search our database by industry and keyword to find the median sale prices of other companies in your industry. Find it all at www.inc.com/valuation.