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Most startups will try to place a valuation on their company when they are looking for investors. Valuations are crucial for investors and founders because they need to make sure all parties involved are getting a fair deal. This can be particularly difficult for app startups, because of the lack of physical assets and intellectual property that is inherent.
However, the simplest way app startup founders can get a realistic idea of their businesses worth is by putting a number value on the user base they have acquired.
Disclaimer: Only use this method if your end users are the paying customers.
This formula will give you the total value of your app’s user base. The average lifetime value [LTV] of a user is the average amount of money they will spend using your product or services. When you subtract the cost to acquire one customer through marketing or sales from LTV, you get the net profit for each user your app has. All you have to do is multiply this number by the number of users you have to get a realistic idea of the total value of your app’s user base.
For example, say you have 40,000 users on your new personal finance app, and you figured out that through in-app purchases, the LTV of each user is approximately worth $35, and your CAC is $6. This gives your company a valuation of $1,160,000 (40,000 x ($35-$6))
Keep in mind this is a very basic formula, and will not give you a 100% accurate valuation of your startup. Many other factors may raise or decrease your valuation, but target market, user base growth, engagement, and churn rate are the most important.
It’s important to analyze your user base growth in context. Growth is not a constant goal for startups, so you have to be strategic when deciding between investing money in growth and investing money in developing the product. According to Y Combinator founder, Paul Graham, there are three phases during the growth of a successful startup.
1. There's an initial period of slow or no growth while the startup tries to figure out what it's doing. This period is when the startup is working to find product-market fit. Growth shouldn’t be a significant factor in valuation when you’re in this stage.
2. As the startup figures out how to create something lots of people want and how to reach those people, there's a period of rapid growth. If you can’t grow quickly during this stage, there may be a problem. Growth should be a big factor in your company's valuation.
3. Eventually, a successful startup will grow into a big company. Growth will slow, partly due to internal limits and partly because the company is starting to bump up against the limits of the markets it serves. When you’re this large, you shouldn’t devalue your company because growth is slowing. That’s a natural effect of the market.
Young startups should be focused more on engagement, as new companies are still trying to figure out what their customers actually want. Only after the foundation is built does growth rate becomes important.
How much engagement is your app driving? Snapchat’s $20 billion valuation was predicated on how important the app is to the daily lives of its users’. Their Millennial “addicted users” use Snapchat 18 times a day on average. With 68 million daily active users they are getting over a billion launches every single day.
While you’re still in the first startup stage (above) consider your engagement level a big factor in valuation. Most startups don’t obtain massive sales volume from the start, so they have to estimate what they think sales volume will be in the future. The best way to forecast future sales is current engagement. If people are spending a lot of time in your app and are coming back - it's a sign they really like your app. Even if they aren’t paying right now, there’s a high chance they will in the future.
Think about your experiences when paying for apps. If you download a free app and enjoy it, you’ll consider paying for in-app purchases. You wouldn’t make those purchases right when you download it because you’re not aware of the value it provides yet. Everybody thinks this way. Don’t expect massive sales before you have even shown value.
When it comes to mobile startups the demographics of your user base also play into engagement一 specifically age. Studies have shown that people of different ages have various needs that affect their usage and evaluation of apps. The graph above shows the direct correlation between how old your users are and the amount of time they’ll spend using your app.
Millennials are highly sought after because 18-34-year-olds are the heaviest mobile app users in the U.S with an average of 90 hours of usage/month. If millennials are your app’s primary users, it's easier to get a higher valuation because of the direct link between engagement and money spent.
How long are people using your app for until they stop using it? Investors will be keeping a close look on your churn rate, because if people are dropping off after a few days or weeks, your app does not have product market fit, and therefore would not be worth investing in.
There is no “ideal churn rate” because once again, every app and industry are different, but you should always aim to reduce churn as much as possible. It’s cheaper to retain an existing customer than acquire a new one.
On the other hand, if your retention rate exceeds industry baselines, you can expect a higher valuation. According to Localytics, you should strive to meet and exceed a retention rate of 25% at 90 days.
Churn Rate = (1 - Retention Rate)
You can find your retention rate in Google Analytics or iTunes Connect by going to the cohort analysis section. It should look similar to the graph above. In this case, after 12 weeks the average retention rate seems to be slightly over 30%. This means after 12 weeks there is a churn rate of 70%.