Other Startup Valuation Methods
Scorecard Valuation Model, Berkus Methods, What Else?
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 variables that startup valuation methods consider include:
- 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.
Other Methods for Startups
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.
Berkus method
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)
Discounted Cash Flow (DCF) Method
The Discounted Cash Flow (DCF) Method is a more complex valuation model used for startups that have already achieved revenue. This method predicts the future cash flow of the business by assessing historical data and making future projections. This allows investors to see what the return on their investment could be based on the projected future performance of the company. While this model is more accurate for established businesses, it can still be applied to startups with proven revenue streams.
Venture Capital Method
The Venture Capital Method is a more aggressive valuation model used by venture capitalists to determine a startup’s valuation. It is based on the assumption that investors are looking for a significant return on investment, usually 10x or more, within a certain timeframe. This method takes into account the expected exit strategy, such as a sale or initial public offering (IPO), and calculates the potential return on investment based on the expected exit valuation.
Real Options Valuation (ROV) Method
The Real Options Valuation (ROV) Method is a newer valuation model that takes into account the flexibility and strategic options available to a startup. This method allows for the uncertainty and risk involved in a startup’s future to be factored into the valuation. It takes into account the different strategic options available to the company, such as expanding into new markets or pivoting the business model, and assigns a value to those options.
Choosing the Right Valuation Method
It’s important to remember that there is no one-size-fits-all approach to valuing a startup. Each business is unique and may require a different approach to determining its value. It’s crucial for business owners and investors to take into account the specific circumstances of the startup, including its stage of development, industry, and potential growth trajectory, when selecting a valuation method.
It is also worth noting that the valuation of a startup is not set in stone and can change over time. As the business grows and reaches new milestones, its valuation may increase or decrease. This is why it is important to regularly review and update the startup’s valuation to ensure that it remains accurate and reflects the current state of the business.
Conclusion
In conclusion, there are a variety of methods available for valuing startups. From the simple Comparable Investment Method to the more complex Discounted Cash Flow Method, each valuation method offers a different perspective on a startup’s value. It’s important to choose the right method that takes into account the specific circumstances of the business and to regularly review and update the valuation as the business grows and evolves. By taking a strategic approach to startup valuation, business owners and investors can ensure that they are making informed decisions and maximizing their return on investment.
In the aforementioned methods introduced in this article, it is important to note that it is prudent to look at these methods as a secondary cross-check valuation method instead of using them as the primary method. Read about the more popular startup valuation methods here.
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