How do you Value a Pre-Revenue Company?
Valuing a pre-revenue startup company can be a complicated process, especially considering the numerous variables that need quantified. From understanding market trends, the quality and experience of the management team, how big is their unfulfilled niche, and demand for an unknown product, many variables go into researching and creating a pre-revenue company valuation.
Even after evaluating everything combined with the most effective pre-revenue valuation formulas, you should keep in the back of your mind that the best thing you could receive is an estimate for your tech startup.
What’s the Difference Between a Startup Valuation and a Mature Business Valuation?
Before we dive into talking about how to value a pre-revenue tech startup, let’s get started with the basics. What exactly is a startup valuation? Startup valuation is a process that goes into calculating the overall value of a startup company. The methods that are used in this process are essential, as they differ from a company with sales. While business owners would hope for a high valuation, however, pre-revenue investors should aim to have a reasonably lower value that looks to offer a bigger return on investment (referred to as ROI).
How does a mature business valuation differ from a pre-revenue startup valuation?
A business valuation will rely on hard figures and facts, as the company has financial records and steady stream revenue to calculate the overall value of a business. Business valuations typically use the EBITDA formula, which computes the value of a business based on its income before depreciating, taxes, amortization, and interest. Since a pre-revenue company doesn’t have any income, amortization, or profits, pre-revenue companies have to rely on other vital factors to determine the value of their company, pre-revenue.
Factors for Pre-Revenue Startup Valuation
If your company is just getting started, most founders of pre-revenue companies don’t receive as much as they originally anticipate, while investors for these companies also tend to outlay more than they originally expected to invest.
Here are a few important factors that go into a pre-revenue startup valuation:
Proof of Concept
One of the main indicators in the value of a startup company that doesn’t have any revenue is traction. You can get a better understanding of the business by taking a look at the four data points that make up a company’s proof of concept or feasibility:
Growth rate– how much your business has grown on a small budget. This is a great tool to show investors who will be looking for potential growth when you’ve received financial backing.
Marketing effectiveness– if you’re able to attract high-value customers without spending large amounts of money on advertising, you’ll have an easier time attracting investors when your company is in its pre-revenue stages.
The number of people using your product– if you already have customers, you are off to a great start. The more customers you have, the better.
Will They Pay?– It is one thing to say you love a new idea, but will consumers write you a check?
The more that you’re able to prove that your company has a secure grasp on all four of the above-listed concepts, the more investors will be impressed with your growth. Even while your company is in its pre-revenue stages, you’ll be able to provide proof that you have a scalable business idea. This adds value to your business.
Investors won’t want to spend their money on a team that doesn’t seem like they’re set for success. To ensure that investors are interested in investing in your tech startup, take a look to ensure your company team has the following traits:
- Diversity of Skills
Does the team that’s supporting your business include people that have success with other startup tech businesses? Investors will be more interested in spending their money on companies that aren’t full of first-timer tech startup entrepreneurs but have a few experienced members on board.
Ensuring that your startup team has a mix of experienced people that have complementing skills is another way you can ensure your tech startup comes across as stabilized. A computer programmer can’t do everything but themselves. Still, if you’ve got someone on your team who has marketing experience that can connect with the programmer, digital marketing has a higher chance of success for your tech startup.
Not only do you need to make sure that your company has a mixture of experienced people who have complimenting skills, but you also need to do your best to find people that have the time to dedicate to getting the company off of the ground. People at startups work crazy long hours, and not everyone is at that point in their life anymore.
How Investors Value Pre-Revenue Businesses
Taking a look at your company to complete a pre-revenue valuation by yourself can seem like an overwhelming task. You can use the methods of experienced investors to get an estimate of the value of your pre-revenue company. Do your best to get yourself as familiar with these startup valuation methods, as it’ll help you to understand better how to evaluate your company. Let’s take a look at the most common valuation methods for tech startups:
Popularized by Dave Berkus, a founding member of the Tech Coast Angels in Southern California, the Berkus Method takes a look at five important aspects of a startup business. They include:
|Characteristic||Add to Pre-Money Valuation|
|Quality Management Team||Zero to $0.5 million|
|Sound Idea||Zero to $0.5 million|
|Working Prototype||Zero to $0.5 million|
|Quality Board of Directors||Zero to $0.5 million|
|Product Rollout or Sales||Zero to $0.5 million|
Risk Factor Summation Method
Used most commonly with tech startup companies. Each aspect of a company is provided with a rating that’s up to $500,000. That means that the highest valuation that a tech company could receive is $2.5 million. This pre-revenue valuation method takes a detailed look at the risks that are involved with a company launching. Here are some of the risks that are looked at:
- Stage of business
- Funding risk
- Capital risk
- Technology risk
- Competition risk
- Political risk
- Legislation risk
- International risk
- Potential lucrative exit
- Reputation risk
- Marketing risk
An investor will go through and value the risk areas of your pre-revenue startup as such:
-2: very negative, -$500,00
-1: negative, the risk for carrying out a successful startup, -$250,000
0: neutral, $0
+1: positive, +$250,000
+2: positive for starting up and carrying out a successful business, +$500,000
If you’re concerned about the risk that your tech startup may be facing, the Risk Factor Summation Method can help to easily open your eyes to the value of your pre-revenue tech startup.
Common Mistakes When Valuing a Startup Company
It’s easy to make a few mistakes while you’re looking into how to value your company. Here are the most common mistakes that you can easily make (and avoid) while valuing your company:
Valuations Aren’t Permanent
A tech startup company is only worth what investors are willing to pay at a specific point in time. While as the owner of a business, you most likely aren’t going to agree with every valuation that your startup company receives. You must always keep in mind that no valuation, whether it be low or high, is ever permanent (or correct).
Valuations Aren’t Always Straightforward
Just because an investor expresses interest in your company, it doesn’t mean you are both on the same page about everything. When you receive a pre-revenue startup valuation that you’re comfortable with, it’s always a good idea to take time to talk to your investors to make sure that everyone is on the same page about how you should move forward.
Preparing for a Pre-Revenue Evaluation
You must take all of the factors that your tech startup has to offer into consideration to provide yourself with the best valuation you can for your pre-revenue startup. It’s also essential that you, as the business owner, learn how to estimate the value of your company before connecting with the people that might be ready to invest in your company. Experimenting with several different valuation methods will provide you with the opportunity to show your investors that your company has the right growth prospects and worth their money.