How Do You Value a Startup with No Revenue?

I've seen this in my financial model consulting career quite a bit. A new startup is looking to raise money and they need a valuation. The question is, how do you come up with a reasonable or fair value of this entity? We have a lot of different ways to do this and no single way is best. It depends on the situation.

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Valuing a pre-revenue startup involves making assumptions about the future potential of the company, and different methodologies may be better suited for different types of businesses based on industry, development stage, and the nature of the startup's assets. Here's an overview of the methodologies and the types of businesses that might fit best with each:

Cost-to-Duplicate Method:

This approach looks at the hard assets of the startup and estimates the costs to replicate the entire business. It involves calculating how much it would cost to start another company with similar assets from scratch, including the development of any technology, intellectual property, and fixed assets.

Best for: Startups with significant tangible assets or those that have invested heavily in technology or intellectual property development. This could include software companies with a developed product or biotech firms with proprietary research.

Market Multiple Method:

This method involves looking at comparable companies in the industry and the valuation metrics that they are being traded at. This could include looking at valuation ratios relative to user count, growth rate, or other sector-specific metrics.

Best for: Startups operating in industries with a number of recently funded peers or competitors, like tech startups, where there is ample market data on valuations relative to users or other key metrics.

Discounted Cash Flow (DCF) Analysis:

Although the startup has no current revenue, a DCF analysis can still be conducted based on projected future cash flows. This requires making assumptions about the startup's revenue growth rate, profit margins, investment requirements, and the discount rate to apply to future cash flows. Most of the financial model templates here on SmartHelping are great for figuring this out.

Best for: Startups with a clear future revenue model and the potential for stable cash flows, even if they are not currently generating revenue. This method is often used for startups in sectors like SaaS (Software as a Service), where subscription models predict future recurring revenues.

Berkus Method:

Dave Berkus, an angel investor, created this approach for pre-revenue startups. It assigns value to the business based on several qualitative factors like the soundness of the idea, the prototype, the management team, strategic relationships, and product rollout or sales plan.

Best for: Early-stage startups that are pre-revenue and pre-profit but have certain qualitative factors that can be evaluated, such as a working prototype or a strong management team. It is quite useful for angel or seed-stage investment evaluations.

Scorecard Valuation Method:

This method compares the startup to other startups with known valuations and adjusts based on factors such as the management team, the size of the opportunity, product/technology, competitive environment, marketing/sales channels, and need for additional investment.

Best for: Early-stage startups with some operational history but no revenues yet. This could include startups in various sectors where the investor has good benchmarks for valuation factors.

Venture Capital Method:

This involves estimating what the company might be worth at a future date (usually the date when the company is expected to be sold or go public) and working backward to its present value by assuming a rate of return that is acceptable to an investor.

Best for: Startups seeking venture capital, where there might be significant growth potential and a future exit is anticipated. This often applies to high-tech or high-growth sectors like fintech, health-tech, or any innovative field with large market opportunities.

Risk Factor Summation Method:

This technique involves assessing the risk in twelve standard aspects of the startup's business (like management, competition, technology risk, etc.) and adjusting the valuation up or down based on that assessment.

Best for: Very early-stage startups where the risks are high and can be individually assessed. This can apply to a range of startups, from tech to manufacturing, provided that the risks are identifiable and quantifiable.

First Chicago Method:

This is a scenario-based valuation method where three different scenarios (worst case, normal case, and best case) are considered with associated probabilities, and the expected value of these scenarios is calculated.

Best for: Mature startups closer to a liquidity event, which have the ability to forecast their financials in different scenarios. This method is suitable for startups that have begun to generate some revenue or have clear visibility into their revenue model.

Comparables Method:

Here, the value is based on what other similar startups were worth at the same stage of development, adjusted for market conditions and the startup's specific circumstances.

Best for: Startups that are in industries with many comparable companies and available data. E-commerce startups, for example, can be valued based on comparables because there are typically many similar companies with published valuations.

It is important to note that these methodologies are not mutually exclusive and can be used in combination to triangulate a startup's valuation. The choice of method often depends on the availability of data, the stage of the company, and the investment context. It's also influenced by the investor's experience and preference, the perceived potential of the startup, and industry-specific factors. Ultimately, the valuation will be the result of a negotiation between the startup founders and the investors, and it will reflect both the perceived potential and the risk associated with the startup.

Learn more about how startups are valued.

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