3 Ways Angel Investors Value Pre-Revenue Startu... https://medium.com/@harryalford3/3-ways-angel-...

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Feb 20 · 4 min read

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3 Ways Angel Investors Value Pre-Revenue
Startups
It’s always an interesting discussion when valuing early stage startups
without existing revenue. Fundamentally, valuing a startup is very
di�erent than valuing an established company. Quantitative analysis

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and �nancial projections don’t always predict the future success of the
early stage startup which is why some angel investors put greater value
in the entrepreneur and management team. No matter the region,
product or industry, investors must reduce risk as much as possible.

There is no one way to determine the pre-money valuation (the

startup’s value before receiving outside investment) so it’s wise to gain
insights on valuation methodologies from other entrepreneurs and
angel investors. Being aware of every method could only help you
leverage and negotiate your own valuation with investors. Below are
three pre-money valuation methodologies that are often used by angel
investors:

Scorecard Valuation Method

The Scorecard Valuation, also known as the Bill Payne valuation
method, is one of the most preferred methodologies used by angels.
This method compares the startup (raising angel investment) to other
funded startups modifying the average valuation based on factors such
as region, market and stage.

The �rst step is to determine the average pre-money valuation for pre-
revenue startups. Angel groups tend to examine pre-money valuations
across regions as a good baseline. I recommend AngelList as a great
resource to explore startup valuation data from thousands of startups.

The next step is to compare the startup to the perception of other

startups within the same region using factors such as:

Strength of the Management Team (0–30%)

Size of the Opportunity (0–25%)

Product/Technology (0–15%)

Competitive Environment (0–10%)

Marketing/Sales Channels/Partnerships (0–10%)

Need for Additional Investment (0–5%)

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Other (0–5%)

The ranking of these factors is highly subjective, but the main emphasis
besides scalibility is on the team. Payne states, “In building a business,
the quality of the team is paramount to success. A great team will �x
early product �aws, but the reverse is not true.”

Lastly, you calculate the percentage weights. Below is a table that

Payne uses in his worksheet:

Click here for more details

Venture Capital (VC) Method

The VC Method, �rst made popular by Harvard Business School
Professor Bill Sahlman, works its way to pre-money valuation after �rst
determining the post-money valuation using industry metrics. By
applying the VC Method to solve for the pre-money valuation of a
startup it’s important to know the following equations:

Post-money valuation = Terminal value ÷ Expected Return on

Investment (ROI)

Pre-money valuation = Post-money valuation—Investment

The terminal value is the anticipated value of an asset on a certain date

in the future. The typical projection period is between four to seven
years. Due to the time value of money the terminal value must be
translated into present value to be meaningful.

By researching the average sales of established companies within the

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same industry (at the end of the projection period) and multiplying the
�gure by a multiple of two, we can calculate the terminal value. For
example, lets assume your startup is raising $500K and expecting to be
generating $20M when you sell the company in �ve years.

Terminal Value = $20M x 2 = $40M

The statistical fail rate for angel investments is over 50% so investors
typically target 10x-30x ROI on each individual investment. To be
conventional, we’ll set the anticipated ROI at 20x for the pre-revenue
startup. Knowing you’re raising $500K, we’ll then work the math
backwards to calculate the pre-money valuation.

Post-money valuation = $40M ÷ 20x = $2M

Pre-money valuation = $2M—$500K = $1.5M

Click here for more details

Berkus Method
According to super angel investor, Dave Berkus himself, the Berkus
Method, “assigns a number, a �nancial valuation, to each major
element of risk faced by all young companies—after crediting the
entrepreneur some basic value for the quality and potential of the idea
itself.”

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The Berkus Method uses both qualitative and quantitative factors to

calculate a valuation based on �ve 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)

But the Berkus Method doesn’t stop with just qualitative drivers—you
must assign monetary value to each. In particular, up to $500K. $500K
is the maximum value that can be earned in each category, giving the
opportunity for a pre-money valuation of up to $2M-$2.5M. Berkus sets
the hurdle number at $20M (in �fth year in business) to “provide some
opportunity for the investment to achieve a ten-times increase in value
over its life.”

Click here for more details

It’s important for you, the entrepreneur, to consider suggestions and

methods to value your early stage startup without existing revenue.

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How to estimate the value of your startup before raising investment

from angel investors is paramount. It’s also important to understand
your investors interest such as the size of the exit they are striving for.
However, there is no universal truth when it comes to valuations so be
�exible.

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