How do I value a pre-revenue startup ?

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Last week we learnt the Comparables method of startup valuation but that was for startups which have revenue or some other metrics.


There are a bunch of methodologies to value a Pre-revenue startup also. Some of the most popular ones are as below:

1) Venture Capital Method
2) Berkus
3) Scorecard
4) Risk Factor Summation

I will start with the 1st and most popular one which most of the investors out there use - 

The Venture Capital method: 
 
In this approach, the value of the startup is determined based on the amount of capital that has been invested in the company by venture capitalists, along with the expected return on that investment. 
 
Some basic definitions -

Terminal Value(TV) is the value at which the investor thinks they can exit the company

Return Multiple (X) is the expected multiple of return on capital invested
 
Let’s take an example with some assumptions and see how this works.

Terminal Value(TV) = $100M
Return Multiple (X) = 20X
 
Post Money Valuation (A) = TV/X = $100M / 20 = $5M
 
Funding Round Size (B) = $1M
 
Pre Money Valuation (C) = A-B = $5M - $1M = $4M
 
Now we need to factor in the amount of stake dilution which can possibly happen from the round you invested in till the round of exit at $100M. Typically it takes 3-4 rounds at least to reach $100M of valuation.
 
Dilution (D) = 50% (let's assume 50% for the sake of simplification)
 
Entry Pre Money Valuation (E) = C*D = $4M *50% = $2M 
 
Hence, you need to enter in at a $2M pre money valuation in this case to make your return multiple 20X by the time startup reaches $100M in valuation.
 
This method can be useful for providing a sense of the market's confidence in the company, but it may not reflect the company's true value if the venture capitalists have over- or under-valued the company. Also, it doesn’t take into consideration any aspects of the business like team, market, competition, moat, etc.

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