Business valuation: How to value a start up

Valuation of a pre-revenue company is often one of the first points of contention that must be negotiated between angels and entrepreneurs due to the fact that there is no agreed upon standards for startups and that the goals of the negotiating parties are opposite since entrepreneurs want the value to be as high as possible and investors want a value low enough so that they own a reasonable portion of the company for the amount they invest.

Experts suggest four methodologies that work for angels and startups.

These offer an excellent starting point to assess the value of a startup:

Berkus method:

Valuation based on the assessment of 5 key success factors. It attributes a range of monetary values to the progress startup entrepreneurs have made in their commercialization activities.

First, you have to know how much a similar startup is worth. Then, you assess how you perform in the 5 key criteria for building your company:

The Berkus Method is meant for pre-revenue startups and  will give you a rough idea of how much your company is worth (pre-money valuation) and what you should improve.

Risk factor summation:

Valuation based on a base value adjusted for 12 standard risk factors. Compares 12 characteristics of the target company to what might be expected in a fundable seed/startup company.

It is a slightly more evolved version of the Berkus Method. First, you determine an initial value for your company. Then you adjust said value for 12 risk factors inherent to company -building.

Initial value is determined as the average value for a similar company in your area, and risk factors are modelled as multiples of $250k, ranging from $500k for a very low risk, to -$500k for a very high risk.

The Risk Factor Summation Method is meant for pre-revenue startups.

Scorecard Method:

Valuation based on weighted average value adjusted for a similar company. It adjusts the median pre-money valuation for seed/startup deals in a particular region and in the business vertical of the target based on seven characteristics of the company.

It starts the same way as the RFS method i.e. you determine a base valuation for your startup, then you adjust the value for a certain set of criteria. Nothing new, except that those criteria are themselves weighed up based on their impact on the overall success of the project.

This method can also be found under the name of Bill Payne Method, considering 6 criteria: Management (30%), Size of opportunity (25%), Product or Service (10%), Sales channels (10%), Stage of business (10%) and Other factors (15%).

The Scorecard Valuation Method is meant for pre-revenue startups.

Venture capital Method:

Valuation based on the ROI expected by the investor. Calculates valuation based on expected rates of return at exit. It stands from the viewpoint of the investor.

An investor is always looking for a specific return on investment, let’s say 20x. Besides, according to industry standards, the investor thinks that your company could be sold for $100M in 8 years. Based on those two elements, the investor can easily determine the maximum price he or she is willing to pay for investing in your startup, after adjusting for dilution.

The Venture Capital Method is meant for pre- and post-revenue startups.

The most difficult part in most of these valuation methods is finding data about similar companies.

There is no perfect methodology to establish the pre-money valuation of pre-revenue ventures, making it even more important for investors and entrepreneurs to know how the number is derived.

Since most startups have little-to-no history, revenue and earnings, there isn’t much information to analyze or plug into a spreadsheet. To close this gap, angels can look for clues from similar startup deals in the same region and industry. Valuations could go up and down depending on market forces, may also be adjusted up or down based on the strength of the management team, location of the business, industry or market.

Valuations are a good starting point when considering fundraising; they help building up the reasoning behind the figures and objectify the discussion. But in the end, the game of supply and demand is significant.

This post is based on Stephane Nasser post published in www.starupsventurecapital.com