Startup Evaluation: methods & examples for early and pre-revenue stage
Evaluation of profitable business is calculated based on sales traction, past years revenues and other metrics. You also can use this formula for late stage startups. But there is no sales traction at the early stage yet, and therefore pre-revenue startups cannot use traditional valuation methods to estimate the value of their business.
Business plans and financial forecasts don’t give you much information about a company, so evaluation of early stage startups is a potential assessment of the ability to realize it. There are several methods of startup evaluation that are used by angel investors and VCs during due-diligence.
1. Venture Capital Valuation Method
Most common stage: Seed, Series A
This method is based on the predicted cost of a startup at the moment the investor exits the company therefore there is no revenue in the first years.
ROI = terminal value/ post-money valuation;
Post-money valuation = terminal value / anticipated ROI
Terminal value: described as the selling price for the company at some point in the future and can be estimated by projecting a reasonable expectation for revenues in the year of sale and, based on those revenues, estimating earnings.
Anticipated ROI: the majority of VCs usually expect a 10–40x return on investment. Considering the described calculation logic, the pre-money valuation can be obtained in the following way:
Post-money valuation: €35m (terminal value) / 20x (anticipated ROI) = €1.75m
Pre-money valuation: €1.75m — €300,000= €1.45m
2. Scorecard Valuation Methodology
Most common stage: Pre-Seed
This is one of many methods using comparison with similar or competitive companies on the market to evaluate a particular startup.
While executing the assessment, you should weigh many factors and give them a score from -3 (worst) to +3 (best). Each score should be multiplied against the comparison factor range (you can find it in the table below). Then you should sum up numbers of factors and multiply this against the average pre-money valuation for the startup’s industry.
The significant disadvantage of the scorecard method is the lack of information about the startup (because every investor evaluates the startup team in his own way) or about its value. In addition, this method cannot be used for disruptive startups that are not typical for the industry like SpaceX, Palantir, 10X Genomics, Vir Biotechnology, Databricks, Rivian and others.