Valuation seems like fairly straightforward process in theory, but in reality it is usually quite the contrary for most businesses. For startups with little to no starting revenue and an uncertain perception of future transactions, the valuation assignment process can become tricky. Still, regardless of whether you are a startup founder or a curious investor, the valuation process is more than worth it.
Here are a helpful approaches to keep in mind along the way.
A consistently popular valuation approach, the Venture Capital method calculates valuation based on the expected rates of return at exit for potential investors. Naturally, the method is also regularly cited as “one of the most useful means of establishing valuation for pre-revenue startups,” giving investors a significant amount of foresight with which to form a financial decision.
The Venture Capital method uses a specific equation as its foundation: “Return on Investment (ROI) = Terminal (or Harvest) Value ÷ Post-money Valuation.” Then, “Post-money Valuation = Terminal Value ÷ Anticipated ROI.”
Many fans of the Venture Capital method will likely also favor the Market Multiple approach, as it provides “a pretty good indication of what the market is willing pay for a company.” Put simply, this method stacks the startup in question up against acquisitions of similar companies operating in the same market — or a similar market — using this information as a basis for how the investment process might go. Again, investors will have a fair amount of foresight to fall back on in this scenario, and they may be willing to take more risks or pay slightly higher prices as a result.
Another well-known valuation technique, the Berkus method is a “simple and convenient rule of thumb” used to assess a startup’s overall value. Basically, the Berkus method hinges on first determining a broad revenue figure that investors think a startup can reach over a reasonable period of time. Then, these investors apply this figure to valuation criteria focused on potential sales and overall execution, among other key variables. Like the preceding methods, the Berkus method is also best utilized in pre-revenue valuation scenarios.