An adequate valuation for a long standing cash cow with overflowing EBITDA isn’t easy to do, far more for a pre-revenue startup built on a great idea and mainly sweat equity. The riddle of the Sphinx may be easier to solve in many cases! We are not going to examine unicorns in this instance. What we shall now do is provide a simple framework for understanding how to find a comfortable ballpark valuation for a pre-revenue startup with strong growth potential using both industry data and weighted percentages via the Scorecard Valuation Method.
The Scorecard Valuation methodology was fully developed by Bill Payne, the Angel Capital Association’s 2009 US Angel Investor of the Year, with full details presented in his book, The Definitive Guide to Raising Money from Angels. The Ohio TechAngels swear by this methodology, renaming the method the Bill Payne valuation method. Other Angels in the industry refer to this method as the Benchmark Method. I personally like this method. Usually for pre-revenue startups we work with projections based mainly on industry figures, projected sales and do a quick and dirty valuation of 2x sales over three years. This works in cases where industry sales trends are very much the norm. However, the Scorecard Methodology introduces individual weighted percentages based on a detailed number of quantitative and qualitative factors per categories, which really assist to encompass the nitty-gritty worth of the startup at inception.
#1 Finding The Average Industry Pre-Money Valuation
It may be possible to get this information from the Angel Capital Association with some investigating, but there is satisfaction in building your own model! In Bill Payne’s example, he surveyed 13 top Angel Associations in the US in 2010 for their portfolio pre-money valuation statistics for pre-revenue startups, which turned out to be:
Remember, these were not portfolios filled with unicorn startups, so the outliers didn’t skew the numbers significantly. This is a great step for an Angel investor. An entrepreneur might be gun shy in contacting all these Angel groups, so I strongly suggest going to, CrunchBase, or AngelList, go to the top 10 competitors in the industry and possibly geography, find their pre-money valuations and then find the average to use as the industry pre-money valuation. For this example, let’s say that the pre-revenue startup has an industry pre-money valuation of US$1.5 million.
#2 Determining The Individual Weighted Averages
We shall do this according to the following criteria:
- Strength of the Management Team: 0-30%
- o Is the team complete? Experienced? Coachable?
- Size of the Opportunity: 0-25%
- Quantifiable target market $
- Product/Technology: 0-15%
- IP well defined? Traction?
- Competitive Environment: 0-10%
- Barriers to entry?
- Marketing/Sales Channels/Partnerships: 0-10%
- Key beta testers? Key partners?
- Need for Additional Investment: 0 – 5%
- Angel? VC?
- Other: 0 – 5%
- Geographical factors?
The actual valuation worksheet is extensive, but here we get the general idea of how to weight the pre-revenue startup. As we see, “Strength of the Management Team” is and will always be the most important factor in valuing a startup (and any company)!
#3 Assigning Comparison Factors To The Percentage Weights
In this example let us say this is the winning pre-revenue startup, so we assign the maximum percentage weights. We then need to add a business sector comparison percentage. This part is a bit tricky and calls for strong sector research. Let’s surmise that the company is in a sector that usually has a strong team background, but the company surpasses the sector in product technology. In this case, we will assign 100% comparison to strong team background, and 150% to product technology. Here is a table similar to what Bill Payne provided for clarity:
#4 Multiplying The Sum Of The Factors
For the final step, we multiply the sum of the factors, 1.1300, by the average industry pre-money valuation in step one, US$1.5 million, to get our own company pre-money valuation. Here, we have a pre-money valuation of US$1.7 million dollars! Not too shabby.
So many entrepreneurs and seed capital investors tend to be lost at sea when it comes to understanding startup valuations. And with the advent of unicorns, the process became even more confounding! Bill Payne’s Scorecard Valuation Method helps greatly with obtaining a ballpark valuation for pre-revenue startups, with good industry and sector research, and a very introspective and honest understanding of one’s own startup objectives.