What’s the best way to get seed-stage startup valuations?
It’s a difficult question, and one with many answers. This post will provide a guide to 3 different types of valuation for early-stage companies: the Scorecard Method, the Berkus Method, and the Risk-Assessment Summation Method. The frameworks will be examined within the scope of an anonymous, real-world company that Valor recently screened as part of our due diligence process.
Seed stage startup valuations
It’s important to note that these frameworks are for pre- or minimal-revenue startups. These descriptions of methods for valuation of early-stage companies are geared towards aspiring and established VCs as well as entrepreneurs raising capital. It will provide a basic understanding for entrepreneurs of how VC’s evaluate the value of their business.
Entrepreneurs and startup valuations
Founders are, by nature, very driven, which leads to ambitious goals and valuations. However, there is a specific valuation amount or range associated with given startups, and targeting valuations outside of the realm of what a VC is prepared to evaluate a business leads the investor to come to the conclusion that the founder isn’t properly prepared or doesn’t understand the scope of what their undertaking really requires.
Seed stage startup valuation frameworks
- SCORECARD METHOD: The Scorecard Method examines a startup in question against other startups in the same industry and adjusts the average valuation of funded companies within the space accordingly to come to a pre-money valuation.
How to Do It:
1. Determine the average pre-money valuation of pre- or minimal-revenue companies in the business sector and region.
2. Compare the target company to the perception of similar deals done in the sector to create a weight percentage along the following business segments:
- 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%)
- Other (0-5%)
3. Take your Target Company and compare it to the industry averages in each of the above business segments (100% = Average, 150% = Above Average).
4. Multiply the sum of factors (Weight % x Target Company) by the Average Pre-Money Valuation to get a comprehensive pre-money valuation of the startup in question.
What It Does:
1. The valuation method places special importance on the competency of the team.
2. The framework provides a pre-money valuation of a very early-stage (angel/seed) company.
Drawbacks:
1. The framework can be subjective and highly dependent on the evaluation biases of the investor.
2. The framework varies with the economy and competitive environment for different startup ventures.
Template for Usage:
| Scorecard Method | |||
| Category | Weight % | Target Company | Factor |
| Management Team | 0% | 0% | 0 |
| Size of the Opportunity | 0% | 0% | 0 |
| Product/Technology | 0% | 0% | 0 |
| Competitive Envrionment | 0% | 0% | 0 |
| Marketing/Sales Channels/Partnerships | 0% | 0% | 0 |
| Need for Additional Investment | 0% | 0% | 0 |
| Other | 0% | 0% | 0 |
| Sum | 0 | ||
| Average Pre-Money Valuation | $0 | ||
| Valuation (M) | $0 | ||
2. BERKUS METHOD: The Berkus method has been around for a long time, and gives an example of a framework that examines the segments of a business (product, market, team, stage, channels, size of market) and assigns a value to each, with the sum of each segment leading to a comprehensive valuation. This method uses both qualitative and quantitative factors to evaluate a business. However, the framework should allow for a higher maximum value to account for additional business segments, as the current framework only allows for a pre-money valuation of up to $2.5 M. The matrix also needs to be more easily modified to respond to altered circumstances or conditions.
How to Do It:
1. Establish the 5 elements of evaluating the business, generally the following:
- Sound Idea
- Prototype
- Quality of the management team
- Strategic Relationships
- Product Rollout or Sales
2. Assign a monetary value to each (between $0-500K, $300K is considered “sound”). This allows for a pre-money valuation of up to $2.5 M.
3. Add the respective monetary value for each business element.
What It Does:
1. The Framework uses qualitative and quantitative factors to evaluate a business.
Drawbacks:
1. The framework should allow for a higher maximum value on elements not listed in the matrix. For example, the pre-money valuations might be competitively higher in the Southeast than in New York City.
2. The matrix given in the method should be able to be easily modified to respond to altered circumstances or conditions.
Template for usage:
| Berkus Method | ||
| Factors | Range | Assessment |
| Sound Idea | $0-500000 | $0 |
| Prototype | $0-500000 | $0 |
| Management Team | $0-500000 | $0 |
| Strategic Relationships | $0-500000 | $0 |
| Product Rollout or Sales | $0-500000 | $0 |
| Sum | $0 | |
3. RISK FACTOR SUMMATION METHOD: Very similar to the scorecard method, the Risk Factor summation method takes a comprehensive examination of the segments of a business and assigns a rating to each component with a subsequent dollar value associated to each rating. The “summation” of the dollar value of ratings for each component results in a comprehensive pre-money analysis of the company. This method is very similar to the scorecard method described above.
How to Do It:
1. Start with the average industry pre-money valuation.
2. Address a list of risks associated with the startup and its industry, typically the following:
- Risk of the management team.
- Business Stage
- Legislation risk
- Manufacturing risk
- Risk of the Sales and Marketing Channels
- Risk of fundraising or Capital Raising
- Competitive Risk
- Technological Risk
- International Risk
- Reputation Risk
- Exit Value Risk.
3. Assign values to each of the risks according to a scale from -2 to 2 and assign $250,000 accordingly (i.e. assigning a “1” value provides a value of $250,000, assigning a “-2” value provides a value of -$500,000)
4. Add the respective monetary values assigned to each business risk.
What It Does:
1. The framework uses both qualitative and quantitative factors to evaluate the business.
Drawbacks:
1. The framework requires a heavily experienced eye for judgment of business performance.
Template for Usage:
| Risk Factor Summation Method | ||
| Category | Rating | Adjustment to Pre-Money Valuation |
| Management Risk | 0 | $0 |
| Stage of the Business | 0 | $0 |
| Legislation/Political Risk | 0 | $0 |
| Manufacturing Risk (or Supply Chain Risk) | 0 | $0 |
| Sales and Marketing Risk | 0 | $0 |
| Funding/Capital Raising Risk | 0 | $0 |
| Competition Risk | 0 | $0 |
| Technology Risk | 0 | $0 |
| Litigation Risk | 0 | $0 |
| International Risk | 0 | $0 |
| Reputation Risk | 0 | $0 |
| Exit Value Risk | 0 | $0 |
| Sum | $0 | |
A seed-stage valuation example
Our sample company, to which we’re going to apply each respective framework in an effort to value the company, is a very early-stage company with two months of operation and growing software revenue under its belt. Though the two months of revenue isn’t nearly enough to base an evaluation on (hence the usage of our pre- and minimal-revenue frameworks introduced in the post), the company features two exceptional months of revenue and an intriguingly high growth rate in revenue between the months. The first-time founders are ambitious, promising, diverse, and have impressive career resumes, though they don’t necessarily apply to the product they are creating. However, there are some concerns with the company, namely its lack of strategic partnerships, as 90% of their revenue is drawn from one client. In addition, the market the early-stage company is attempting to capture is fairly competitive and on the smaller side.
Determining the startup valuation
Using the three frameworks provided in this post, the startup in question is valued at a range from $1.05 M to $1.25 M.
| Valuation Summary | |
| Type | Valuation Amount (Pre-Money) |
| Scorecard | $1.19 |
| Berkus | $1.05 |
| Risk Factor Summation Method | $1.25 |
Example 1 – APPLYING THE SCORECARD METHOD:
Using the Scorecard method, the weights attributed to the segments of the sample startup (along with the reasons for the weights in parentheses) are weighted against the industry norm as follows:
Management Team: 100% (Average)
Size of the Opportunity: 70% (Smaller Market)
Product and Technology: 60% (Need to Build Out Their Product)
Competitive Environment: 75% (Fairly competitive)
Marketing, Sales Channels and Partnerships: 50% (Not Fully developed)
Need for Additional Investment: 100% (Average)
Other intangibles: 100% (Average)
In accordance with this evaluation, the categories are multiplied by the max of their ranges to arrive at a factor. These factors are then added to get a factor sum of 0.685, which is then multiplied by the industry valuation average for comparable companies ($1.5 M) to get a valuation of $1.19 M. Below is a spreadsheet detailing the process.
| Scorecard Method | |||
| Category | Weight % | Target Company | Factor |
| Management Team | 30% | 100% | 0.3000 |
| Size of the Opportunity | 25% | 70% | 0.1750 |
| Product/Technology | 15% | 60% | 0.0900 |
| Competitive Environment | 10% | 75% | 0.0750 |
| Marketing/Sales Channels/Partnerships | 10% | 50% | 0.0500 |
| Need for Additional Investment | 5% | 100% | 0.0500 |
| Other | 5% | 100% | 0.0500 |
| Sum | 0.7900 | ||
| Average Pre-Money Valuation | $1.50 | ||
| Valuation (M) | $1.19 | ||
Example 2 – APPLYING THE BERKUS METHOD:
Using the Berkus Method, the 5 startup components described above are weighted along the $0-500,000 range as follows (with explanations in parentheses):
Sound Idea: $250,000 (Average)
Prototype: $200,000 (Insufficient Technology)
Management team: $250,000 (Average)
Strategic Relationships: $200,000 (Require More partnerships)
Product Rollout or Sales: $150,000 (Not Fully Developed)
These values are added up to get a valuation of $1.05 M. Below is a spreadsheet detailing the process.
| Berkus Method | ||
| Factors | Range | Assessment |
| Sound Idea | $0-500000 | $250000 |
| Prototype | $0-500000 | $200000 |
| Management Team | $0-500000 | $250000 |
| Strategic Relationships | $0-500000 | $200000 |
| Product Rollout or Sales | $0-500000 | $150000 |
| Sum | $1,050,000 | |
Example 3 – APPLYING THE RISK FACTOR SUMMATION METHOD:
Using the Risk Factor Summation Method, the 12 Factors described above are weighted as follows (with explanations in parentheses):
Management Risk: +1 (Solid founders)
Business Stage: +2 (Early with Strong Revenue Growth)
Legislation Risk: 0 (Non-Factor for the Industry).
Manufacturing Risk: 0 (Non-Factor for the Industry)
Sales and Marketing Channel Risk: -1 (Not fully developed)
Funding Risk: +1 (Early Stage)
Competition Risk: -1 (Fairly Competitive Industry)
Technology Risk: 0 (Average Technology)
Litigation Risk: 0 (Non-Factor for the Industry)
International Risk: 0 (Non-Factor for the Industry)
Reputation Risk: +1 (Industry Based on Company Reputation)
Exit Value Risk: +1 (Company Has Had Exits in Industry Before)
When these factors are assigned dollar values in accordance with their weighting (i.e. $250,000 for 1, -$250,000 for -1), the sum of the dollar values is $1.25 M, resulting in a pre-money valuation for the target company. Below is a spreadsheet detailing the process.
| Risk Factor Summation Method | ||
| Category | Rating | Adjustment to Pre-Money Valuation |
| Management Risk | 1 | $250000 |
| Stage of the Business | 2 | $500000 |
| Legislation/Political Risk | 0 | $0 |
| Manufacturing Risk (or Supply Chain Risk) | 0 | $0 |
| Sales and Marketing Risk | -1 | ($250000) |
| Funding/Capital Raising Risk | 1 | $250000 |
| Competition Risk | -1 | ($250000) |
| Technology Risk | 1 | $250000 |
| Litigation Risk | 0 | $0 |
| International Risk | 0 | $0 |
| Reputation Risk | 1 | $250000 |
| Exit Value Risk | 1 | $250000 |
| eSum | $1,250,000 | |
Example conclusion: startup valuation guidance
The close proximity of valuation values ($1.05-1.25 M) speaks to the consistency and effectiveness of creating a valuation using each framework. For the most comprehensive valuation possible, it’s important to consider using all three valuation frameworks.
Want to learn more about the due diligence process? Valor explains our process in detail here
Sources:
Sergio Marrero, “Venture Capital Valuations and Multiples”, Medium, August 15, 2019
Harry Alford, “How Angel Investors Value Pre-Revenue Startups”, Medium, January 17, 2017