Lemonade, one the best known of the technology-driven insurance start-ups, or「insurtechs」, will carry out its initial public offering this week. A 2019 funding round brought in $300m, bringing the total raised by the company to $480m. Lemonade has attracted many big-name backers including Alphabet, SoftBank and Allianz.

IPO valuation

Many investors who participate in IPOs are not aware of the process by which a company's value is determined. Before the public issuance of the stock, an investment bank is hired to determine the value of the company and its shares before they are listed on an exchange.

But smart investors can try to understand a company's financials by looking at its registration documents and assessing the company's financials in order to determine if the stock is priced appropriately. 

In addition, understanding the various components of how an investment bank conducts a company's IPO valuation is important for anyone interested in becoming an early investor.

The components listed below are the influencing factors of IPO valuation.

Demand

An IPO valuation is the process by which an analyst determines the fair value of a company's shares.

Strong demand for the company will lead to a higher stock price. However, strong demand for a company's shares does not necessarily mean the company is more valuable, but it does mean that the company will have a higher valuation.

For example, in 2000, at the peak of the bubble, many technology companies had massive IPO valuations. Compared to companies that went public later, they received much higher valuations, and consequently, were the recipients of much more investment capital. 

This was largely due to the fact that technology stocks were trending and demand was especially high in the early 2000s; it was not necessarily a reflection of the superiority of these companies.

Industry comparables

Industry comparables are another aspect of the process of IPO valuation. If the IPO candidate is in a field that has comparable publicly-traded companies, the IPO valuation will include a comparison of the valuation multiples being assigned to its competitors. 

The rationale is that investors will be willing to pay a similar amount for a new entrant into the industry as they are currently paying for existing companies.

Growth prospects

An IPO valuation depends heavily on the company's future growth projections. The primary motive behind an IPO is to raise capital to fund further growth. The successful sale of an IPO often depends on the company's projections and whether or not it can aggressively expand.

For example, $Warner Music Group(WMG.US)$ raised $1.925 billion on its Nasdaq debut on June 3 and led a hot IPO season. Warner Music will be the only pure record industry growth story investors can bet on in the streaming era, that's why its IPO was in the spotlight.

A compelling corporate narrative

Not all of the factors that make up an IPO valuation are quantitative. A company's story can be as powerful as a company's revenue projections. 

A valuation process may consider whether or not a company is offering a new product or a service that may revolutionize an industry or be on the cutting edge of a new business model.

A good example of this is the companies that pioneered the Internet in the 1990s. Because they were promoting new and exciting technologies, some of them were given valuations of multiple billions of dollars, despite the fact that they were not producing any revenue at the time.

Source: Investopedia