Pre-revenue valuation refers to the process of estimating the value of a startup or a company that has not yet started generating revenue. This can be a challenging task, as there are no historical financial data to rely on and the success of the company is largely dependent on its potential. However, pre-revenue valuation is important for various reasons, such as raising capital, negotiating equity with co-founders or employees, or simply for setting internal targets and milestones.
There are several methods that can be used for pre-revenue valuation, such as the Berkus method, the Scorecard method, the Risk Factor Summation method, and the Stage Capital method, among others.
The Berkus method is a widely used method for pre-revenue valuation. It was developed by Dave Berkus, a venture capitalist and angel investor, and it is based on the idea that the value of a startup is determined by its potential to generate revenue and profits in the future. According to the Berkus method, the valuation of a startup is based on five key factors:
The idea: This refers to the uniqueness and marketability of the product or service that the startup is offering. A novel and in-demand product or service will generally have a higher valuation than a commodity or a me-too product.
The team: The experience, skills, and track record of the founding team are crucial for the success of a startup. A strong and experienced team will be more likely to execute the business plan and achieve the desired results.
The market: The size of the target market and the competition in the market are also important factors. A startup targeting a large and growing market with little competition will generally have a higher valuation.
The execution: The ability to execute the business plan and achieve milestones is crucial for the success of a startup. A startup with a clear and feasible plan and a track record of execution will generally have a higher valuation.
The investor: The investor's experience and track record in the industry and in working with startups is also a factor. An investor with a proven track record of helping startups succeed will generally be able to negotiate a higher valuation.
The Berkus method uses a formula to calculate the valuation of a startup based on these factors. The formula is:
Pre-revenue valuation = $1M x (idea + team + market + execution + investor) Each factor is assigned a value on a scale of 0 to 2, with 0 representing the lowest value and 2 representing the highest value. The total score for all factors should not exceed 10.
For example, if a startup is offering a unique and in-demand product with a strong and experienced team targeting a large and growing market with a clear and feasible plan and an experienced investor, the valuation would be: Pre-revenue valuation = $1M x (2 + 2 + 2 + 2 + 2) = $10M
On the other hand, if the same startup was targeting a small and crowded market with a weak and inexperienced team and a poorly defined plan and an inexperienced investor, the valuation would be: Pre-revenue valuation = $1M x (1 + 0 + 1 + 0 + 0) = $2M
As you can see, the Berkus method takes into account multiple factors and allows for a more nuanced and realistic valuation of a startup. It is important to keep in mind that the Berkus method is just one of the many methods that can be used for pre-revenue valuation and it should be used in conjunction with other methods and considerations.