I have been asked many times by founders how they should value their business when they are looking for funding. Now, whilst establishing a pre-money valuation for your venture might seem like playing darts in the dark, especially when you are pre-revenue or looking for seed funding it’s a challenge that can be overcome with the right methodology and due diligence.
Firstly, let’s clarify. Pre-money valuation is the worth of your company before you get any investment. It’s a crucial figure that affects how much equity you need to part with to secure funding. And while this calculation is straightforward enough for revenue-generating companies, it can feel like a guessing game for pre-revenue startups. Fear not; let’s shed some light on this game.
1. Scorecard Method
This is the most used method for early-stage startups in my experience. It involves comparing your venture with other startups in your sector and region and adjusting the median pre-money valuation based on specific elements of your business. These factors could include the strength of your management team, the size of your opportunity, the product/technology novelty, the competitive environment, marketing/sales channel partnerships, the need for additional investment, and other risk factors.
2. Venture Capital (VC) Method
Venture capitalists often use a method which involves working backwards from your expected exit. Start by estimating the potential exit value of your company in about 5-7 years. Then, factor in the rate of return expected by your investors. The tricky part here is predicting your company’s potential future earnings convincingly.
3. Risk Factor Summation Method
This method involves considering a range of risks associated with your startup such as technology risk, market risk, and team risk. Each risk factor adjusts your valuation up or down, depending on how your company compares with other similar companies. It can show that you are cognisant of this aspect of your business, but again it is hard to agree on values to use because extremes are often challenged. It always feels very subjective when I hear it.
4. Berkus Method
Named after angel investor Dave Berkus, this method places a financial value on five elements: sound idea, prototype, quality management team, strategic relationships, and product rollout or sales. Each aspect can add up to £500,000 to your valuation. This method is also highly subjective but can provide a good starting point.
Tips for Effective Valuation
- Transparency: Always maintain clear and open communications with your potential investors. Be honest about your figures and predictions.
- Justifiable Assumptions: Ensure that any assumptions you make when using these methods are defendable. Base them on credible market research and real-world comparisons wherever possible.
- Flexibility: Remember, valuation is more art than science. Be open to negotiating and willing to find a middle ground with investors.
- External Advice: Don’t shy away from seeking professional advice. The input of experienced financial advisors or seasoned entrepreneurs can be invaluable in this complex process.
Remember, these methods are not foolproof, and the market climate will also significantly affect your valuation. Ultimately, your company is worth what someone is willing to pay for it. And while valuation is important, focus on building a great product or service that solves real problems. Success often attracts investment, regardless of how good you are at crunching the numbers.
