Valuation techniques for pre-revenue start ups

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You need to value your startup for fundraising to assess the distribution of its ownership amongst the investors in return for their investment. At the early stages, the valuation would be based on the start up’s growth and potential. And as your startup matures and gains scale in its revenues, the assessment would incorporate the financial value.

You also need to know the value of your startup to use it as a collateral to secure a loan from a bank as debt capital.

The valuation of a startup is often quipped as an art – requiring creativity – than science due to the little or no revenue and profits and uncertain future. Yet the guess-estimation needs a framework for better accuracy and alignment with market expectation. You may want a high value, but investors prefer a lower value to see a large return on their investment.

So here’s a list of some of the valuation methods for you to choose from:

  • Berkus Method

What is it based on: Assessment of five key success factors

How does it work:

  • You need comparable – implied values of other older companies that have characteristics similar to your startup
  • You evaluate the startup’s performance across the five success factors
  • The sum of all the five values provides an approximate value

Example: (all figures in £ million)

  • Risk Factor Summation Method

What is it based on: Base value adjusted for 12 standard risk factors

How it works:

  • You determine the average pre-money valuation of similar startups in your region
  • Each risk factor is assessed, as follows:
    • +2   very positive for growth
    • +1   positive
    • 0     neutral
    • -1    negative for growth
    • -2   very negative
  • You adjust the values for the 12 risk factors as follows:
    • Add $250,000 for +1
    • Add $500,000 for +2
    • Deduct $250,000 for -1
    • Deduct $500K for -2

Example: (all figures in million £)

  • The Scorecard Valuation Method (also known as the Bill Payne Method)

What is it based on: A weighted average value adjusted for a similar company

How it works:

  • You determine a base valuation for your start up
  • You adjust the value against each criterion in a set of seven
  • Each criterion is weighed up based on their impact on the overall success of the project

Example: (all figures in all figures in million £)

State of your start up:

  • An average product and technology (100% of norm)
  • A strong team (125% of norm)
  • A large market opportunity (150% of norm).
  • Can get to positive cash flow with a single angel round of investment (100% of norm)
  • Weaker against the strength of the competition (75% of norm)
  • Excellent early customer feedback on the product (Other = 100%)
  • Needs some additional work on building sales channels and partnerships (80% of norm)

Other valuation methods for pre-revenue start ups include Venture Capital method or the Comparable Transaction method.

Being flexible as a startup is worth what an investor is willing to invest, even though you might disagree with their valuation. Ideally, you and the investor should believe in the fairness, notwithstanding the desire to receive more value on their side.