12/5/21, 6:54 PM 4 Startup Valuation Methods Used by VCs and Angels

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4 Startup Valuation Methods Used by VCs

and Angels
8 MINS READ

SHARE A lot of startup valuation relies on guesswork and estimation, meaning

that there is no single, universally accepted analytical methodology for

investors. Instead, VCs and Angels will draw upon several venture capital

 valuation methods to understand the value of a startup.

 The use of such valuation methods is dependent upon the stage of a

business, and the corresponding data points available in the market
and/or industry the startup operates in (earnings/revenue/acquisition
multiples etc.). In this article, we’ll be looking at the 4 most commonly
used early-stage and pre-revenue angel and venture capital valuation
methods:

1. Scorecard Valuation Methodology

2. Venture Capital Valuation Method

3. Dave Berkus Valuation Method

4. The Risk-Factor Summation Method

Scorecard Valuation Methodology

This startup valuation method compares the target company to typical
Angel-funded startup ventures and adjusts the average valuation of
recently funded companies in the industry, to establish a pre-money

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valuation of the target. Such comparisons can only be made for

companies at the same stage of development.

The first step is to determine the average pre-money valuation of pre-

revenue companies in the business sector of the target company. Pre-
money valuation varies with the economy and with the competitive
environment for startup ventures within an industry. In most industries, for
pre-revenue startups, the pre-money valuation does not differ too
significantly from one business sector to another.

Based on Seedrs data, as of 2019, pre-money valuations vary from

£750,000 to £2m for seed stage, pre-revenue companies.

The next step is to compare the target company to your perception of

similar deals done in the industry, considering the following:

• Strength of the management team: founders’ experience and skillset,

founders’ flexibility, and completeness of the management team.

• Size of the opportunity: market size for the company’s product or

service, the timeline for increase (or generation) of revenues, and the
strength of competition.

• Product or service: product/market definition and fit, the path to

acceptance, and barriers to entry.

• The sales channel, stage of business, size of the investment round,

need for financing, and quality of business plan and presentation. 

Here is a section of a typical valuation worksheet that has been

developed to assess the relative strength of target companies: 

How does the Scorecard Valuation Methodology

work?
For each comparison factor, like the one shown above, there are a set of
multiple-choice questions to answer about your business. The answers
give you a score in the range of -3 (worst) to +3 (best). You multiply this
score against the comparison factor range (see below), to give each
section a weighting, then you sum up the total factor and multiply this
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12/5/21, 6:54 PM 4 Startup Valuation Methods Used by VCs and Angels

against the average pre-money valuation for your industry, giving you
your estimated valuation.

If this sounds a little complex, don’t worry. We’ve created an interactive

tool that does these calculations for you – all you have to do is answer the
questions. Check out the calculator here:

Calculate Your Startup's

Value
Get started by filling out the details below:

What's the name of your business?*

Email*

Website*

Begin

Venture Capital Valuation Method 

The VC valuation method was first introduced in 1987 by Harvard
Business School Professor Bill Sahlman. It works out pre-money valuation
by first determining post-money valuation, using industry metrics. 

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How does the Venture Capital Valuation

Methodology Work?
The venture capital valuation methodology is simple and stems from the
following equations:

ROI = terminal value / post-money valuation;

Post-money valuation = terminal value / anticipated ROI

Let’s break the formula down to take a closer look:

Terminal value is the anticipated selling price for the company at some
point in the future – assume 5 to 8 years as the average for early-stage
equity. The selling price can be estimated by establishing a reasonable
expectation for revenues in the year of sale and, based on those
revenues, estimating earnings in the year of the sale.

For example, a SaaS company with revenues of £20,000,000 upon exit

might expect to have post-tax earnings of 15% or £3,000,000. Using
available industry-specific price to earnings (PE) ratios, a 15x PE ratio for
our SaaS company would give an estimated terminal value of £45m.

What’s a Price to Earnings Ratio?

Anticipated ROI: all investments must demonstrate the possibility of a 10-
40x return (as per industry norms for early-stage investments), so let’s
assume an anticipated ROI of 25x for this example. We can now use this
information to calculate the pre-money valuation.

Assuming our SaaS entrepreneur needs £500,000 to achieve positive

cash-flow and will grow organically thereafter, we’ll need to calculate the
pre-money valuation of this transaction in the following way:

Post-money valuation: £45m / 25x = £1.8m

Pre-money valuation: £1.8m – £500,000 = £1.3m

What if there is a need for subsequent investment? An easy way to adjust

the pre-money valuation of the current round is by reducing this by the
estimated level of dilution from later investors. 

Dave Berkus Valuation Method

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Dave Berkus is a widely respected lecturer who has invested in more than
80 startup ventures. Dave’s model first appeared in a book published by
Harvard’s Howard Stevenson in the mid-1990s and has been used by
Angel investors ever since.

How does the Dave Berkus Methodology Work?

The most recent Dave Berkus version, updated in 2009, starts with a pre-
money valuation of zero, and then assesses the quality of the target
company in light of the following characteristics: 

Characteristics Add to Pre-Money Valuation

Quality management team Zero to £0.4 million

Sound Idea Zero to £0.4 million

Working prototype Zero to £0.4 million

Quality board of directors Zero to £0.4 million

Product rollout or sales Zero to £0.4 million

For example, if you early-stage business has a good quality management

team, a working prototype and sales, your valuation will be estimated at
£1.2 million following the Dave Berkus method.

Note that the numbers are the maximum for each class so a valuation can
be £800,000 (or less) as easily as £2m. Furthermore, Dave reminds us
that his method “was created specifically for the earliest stage
investments as a way to find a starting point without relying upon the
founder’s financial forecasts.”

The Risk-Factor Summation Method

This approach considers a much broader set of factors in determining the
pre-money valuation of pre-revenue companies. The Ohio Tech Angels,
who developed this method, describe it as follows…

“Reflecting the premise that the higher the number of risk factors, then
the higher the overall risk, this method forces investors to think about the
various types of risks which a particular venture must manage in order to
achieve a lucrative exit. Of course, the largest is always ‘management risk’
which demands the most consideration and investors feel is the most
overarching risk in any venture. While this method certainly considers the

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level of management risk it also prompts the user to assess other risk
types” including: management, stage of the business, legislation/political
risk, manufacturing risk, sales and marketing risk, funding/capital raising
risk, competition risk, technology risk, litigation risk, international risk,
reputation risk, potential lucrative exit. 

How does the Risk-Factor Summation Methodology

Work?
Think about all the risks which you’ll need to assess, with management,
stage of the business, legislation/political risk, manufacturing risk, sales
and marketing risk, funding/capital raising risk, competition risk,
technology risk, litigation risk, international risk, reputation risk, potential
lucrative exit, being the most important ones.

Each of the above risks is then assessed as follows:

+2
very positive for growing the company and executing a lucrative exit

+1
positive

0
neutral

-1
negative for growing the company and executing a lucrative exit

-2 very negative

This is how the Risk-Factor Summation works: the average pre-money

valuation of pre-revenue companies in your industry is then adjusted
either positively by £200,000 for every +1 (+£400,000 for a +2) or
negatively by £200,000 for every -1 (£400,000 for a -2). For example, a
business with no manufacturing risk (+£400,000), no legislation risk (+
£400,000), no reputation risk (+£400,000), low competition so positive for
growing the company (+£200,000), but potential management risk (-
£200,000), will be valued at £1.2m.

Use a Combination of Methods

In summary, good practice suggests using at least three startup valuation
methods to estimate the appropriate pre-money valuation. If all give
roughly the same number, simply average the three. If one is an outlier,
then average the other two, or alternatively use a fourth method in an
attempt to bring three of them in close agreement.

For more information, check out our comprehensive guide: The Art of

Startup Valuation: A Guide for Early-Stage and Pre-Revenue Startups, or to
get an idea of what your startup’s valuation might be, use our Startup
Valuation Calculator.
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12/5/21, 6:54 PM 4 Startup Valuation Methods Used by VCs and Angels

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