More times than not, valuation comes into the picture when business owners are looking to bring in capital through an investment. What is worth keeping in mind is that business owners will generally want to value their company is high as possible, while investors are looking for the lowest valuation possible in order to maximize their return on investment (ROI).
Most valuation models are based on historical revenue figures and hard facts – something that most startups do not necessarily have. With mature companies, a common valuation is done by looking at earnings before interest, taxes, depreciation and amortization (EBITDA). But what about startup businesses who are in their early stages and even in pre-revenue phases?
As the business operation of a startup is usually different to a traditional business, the valuation methods to assess their valuation is different.
Some of the different startup valuation methods consider:
- Rate of return
- Timing and form of return
- Amount of control desired
- Acceptable level of risk
- Perception of risk
- Comparable investments (elsewhere)
The abovementioned are some of the few different factors to take into consideration when valuing a startup. A couple of factors that will raise the valuation are balance in supply and demand, well-functioning distribution channels and the reputation of the founder. On the other hand, a few factors that could lower a valuation are low margins, high competition and a management team without experience. Pre-revenue valuation models are of significant importance when it comes to startups, since most startups do not have revenue in the beginning – let alone profit.
Some Common Approaches
Comparable Investment Method
A useful model is the Comparable Investment Method; it is simply finding out how much similar companies in your industry and region are worth.
Scorecard Valuation Model
A more elaborate approach to startup valuation for pre-revenue startups is the Scorecard Valuation Model. This method compares your startup business to typical angel-funded startup ventures and adjusts the average valuation of recently funded companies in your same region to establish a pre-money valuation of the target.
Another valuation model for startups is the Berkus method. Designed by angel investor Dave Berkus, the Berkus Method uses both qualitative and quantitative factors to calculate valuation based on five elements:
- Sound Idea (basic value)
- Prototype (reduces technology risk)
- Quality Management Team (reduces execution risk)
- Strategic Relationships (reduces market risk)
- Product Rollout or Sales (reduces production risk)
In all the methods introduced in this article, it is important to note that a credible and solid valuation framework will take into account at least two approaches to generate an average that will be more consistent and reliable.
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