Calculating the enterprise value of a startup can be tricky and in most cases represents a mere approximation, especially if the start-up is pre-revenue. Valuation for startups is different from valuing established companies because of the high risk and uncertainty associated with the venture. Startup valuations are largely determined based on qualitative attributes rather than more traditional quantitative methods such as the Discounted Cash Flow. Therefore, valuing startups is more art than science.
Knowing the enterprise value of a startup is critical to raise capital. Most early stage ventures need working capital to develop the prototype, attract key talent, go to market and execute the business plan. Startup valuation can give you an idea of what to expect and what you should be asking and negotiating with the investor. Although there are many valuation tools and methods to value start-ups, the most popular methods used by venture capitalists and angel investors are the Berkus Method, Scorecard Method, Risk Factor Summation Method and Venture Capital Method.
Probably the most popular valuation (pre-money) model for most start-ups, the Berkus Method values early stage (pre-revenue) companies based on five key factors: sound idea, prototype, quality management team, strategic relationships and product rollout. Each factor is assigned a maximum value of $500,000 for a total maximum value of $2,500,000.
Another popular method, the Scorecard Method uses comparable early stage average pre-money value and then compares it to the target start-up. The key factors focus on: strength of the management team (30%), size of the opportunity (25%), product/technology (15%), competitive environment (10%), partnerships (10%), need for additional investment (5%) and other relevant factors (5%).
Risk Factor Summation Method
The Risk Factor Summation Method requires the entrepreneur to determine an initial value and then adjust that value applying 12 risk factors. The initial value is what could be expected in a fundable startup using the same average pre-money valuation of pre-revenue startups in the area. Each element is weighted in multiples of $250,000 ranging from very low to very high risk. The 12 risk factors are: management, stage of the business, legislation/political risk, manufacturing risk, sales/marketing risk, funding/capital raising risk, competition risk, technology risk, litigation risk, international risk, reputation risk and potential exit value.
Venture Capital Method
The Venture Capital Method is based on several key assumptions related to initial investment, required ROI, exit value and investor’s share to then arrive at the post-money valuation.
We have experience valuing startups in several industries. As mentioned, arriving at the right valuation is tricky and requires knowledge and experience. For more information on how to value your startup please contact us.