I’m taking a class on early stage capital. It’s primarily focused on finding angel and venture funding for a start-up company, and structuring subsequent investment agreements.
When a start-up receives funding, it’s pretty important to “know” what the start-up was worth before the funding was received. Otherwise there’s no way to determine what portion of the company is owned by the founders, and what portion now belongs to the new investors. Since most start-ups fail, and the one’s that are successful often blow through their financial projections, traditional discounted cash flow approaches are pretty meaningless.
So how do you value an idea?
I’ve always wondered about this. It’s a subjective process, but start-ups are valued often, so I knew there must be some common frameworks. We recently had an angel investor come speak to our class, and she said she usually uses the Berkus Method:
Here is the latest fine-tuning of the method. You should be able to adopt it to most any kind of business enterprise if your aim is to establish an early, most often pre-revenue valuation to a start-up that has potential of reaching over $20 million in revenues within five years:
If Exists, Add to Company Value up to:
Sound Idea (basic value): $1/2 million
Prototype (reducing technology risk): $1/2 million
Quality Management Team (reducing execution risk): $1/2 million
Strategic relationships (reducing market risk): $1/2 million
Product Rollout or Sales (reducing production risk): $1/2 million
Note that these numbers are maximums that can be “earned” to form a valuation, allowing for a pre-revenue valuation of up to $2 million (or a post rollout value of up to $2.5 million), but certainly also allowing the investor to put much lower values into each test, resulting in valuations well below that amount.
That’s it. It’s simple, it’s reasonable, and the approach avoids extremes.