How Startup Businesses Are Valued

by Craig Anthony

2 min read

While each method of valuing a startup business has its pros and cons, having a general knowledge of more than one may provide you with an advantage when going into investor meetings. Try valuing your startup business with each of these methods, and then perhaps take an average value. This is an important process, as there isn’t an across-the-board rule in startup valuation.

The David Berkus Method

David Berkus, an experienced angel investor, developed the following method to value early-stage startups. He claims that it’s adoptable for any type of business that is pre-revenue and has the potential to reach over $20 million in revenue in the next five years. The maximum value that this method estimates is $2.5 million. Berkus’ method accounts for five variables. For each variable that the startup has, add $500,000 to the startup’s valuation:

  1. A sound idea (basic value)
  2. A prototype (reducing technology risk)
  3. Quality management team (reducing execution risk)
  4. Strategic relationships (reducing market and competitive risk)
  5. Product rollout or sales (reducing financial or production risk)

The Venture Capital Method

The Venture Capital Method was developed at Harvard University. It requires that the startup be sold within a five- to eight-year time frame. The proceeds and the investors’ assumed return on investment are used to calculate the current valuation. A simplified version is calculated as follows:Post-Money Valuation = Terminal Value / Anticipated Return On Investment Pre-Money Valuation = Post-Money Valuation – Investment. Assume an entrepreneur needs $500,000 to grow the business. The investor needs a 20X return for business to be considered a success. The estimated terminal value of the company after eight years is $42.5 million. Thus: Post-Money Valuation = $42.5 million / 20 = $2.125 million Pre-Money Valuation = $2.125 million – $500,000 = $1.625 million

The Scorecard Valuation Method

The Scorecard Method adjusts the median pre-money valuation, based on geography, business type, and seven unique factors. The first step is to determine the average pre-money valuation of pre-revenue companies is a the relevant startup’s region, and business sector of the startup. In most regions, the pre-money valuation does not widely vary across business sectors. The second step is to adjust this median valuation based on the following seven factors. These variables and potential range weights for factor adjustments are:

  • Strength of the management team: 0% – 30%
  • Size of the opportunity: 0% – 25%
  • Product/technology: 0% – 15%
  • Competitive environment: 0% – 10%
  • Marketing/sales, channels/partnerships: 0% – 10%
  • Need for additional investment: 0% – 5%
  • Other: 0% – 5%

The Risk Factor Summation Method

This method looks at 12 different characteristics of the startup: management, stage of the business, legal/political risk, manufacturing risk, sales and marketing risk, funding/capital risk, competition, technology risk, litigation risk, international risk, reputation risk, and the potential for a lucrative exit. Each factor is rated on the following scale:2 = very positive1 = positive0 = neutral-1 = negative-2 = very negativeThe valuation is adjusted positively by $250,000 for every +1 (+$500K for a +2) and negatively by $250,000 for every -1 (-$500K for a -2). Remember, it is important to value your small business before pitching to investors. This not only shows that you are prepared but that you are knowledgeable about the business process. Using several methods to value a business is beneficial as it gives you a more accurate valuation.

References & Resources

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