Putting a price on potential: Valuation methods for pre-revenue UK startups
Jump to
- Why Valuation Matters
- The Berkus Method
- The Scorecard Valuation Method
- Market Comparables
- The Bottom Line
Valuing established startups with revenue is relatively straightforward – you can rely on the numbers. However, when it comes to UK pre-revenue startups, it gets more complex. A significant part of their value lies in intangible assets like the team’s expertise, intellectual property, market potential, strategic partnerships, and market traction. These aspects don’t fit neatly into traditional financial metrics. Yet, while you can’t put an exact price on these intangibles, it goes without saying that they carry immense weight with potential investors.
In this blog post, we’ll delve into the toolkit of valuation methods tailored to pre-revenue valuation, which shift the focus from purely financial data to recognising the innovation that these startups bring to the table. Getting this valuation right is crucial, especially when you’re seeking investment or figuring out how to distribute equity among founders.
As with all our articles, please don’t take this as personal tax, financial or other advice (you need to speak to us for that).
Why Valuation Matters
Valuation isn’t just about assigning a number to your startup; it’s an internal barometer of your startup’s growth and a strategic asset in your entrepreneurial journey. A well-considered valuation serves several crucial purposes:
- Reflecting Value & Direction: A well-considered valuation helps you to frame funding discussions and set the stage for negotiation. It’s a tangible testament to your months (or years) of hard work, providing a sense of direction and achievement. This powerful tool can help you to frame conversations with investors and acts as a strong starting point for negotiations.
- Strategic Decision-Making: Valuation is integral to crafting your business strategy, equipping you with the insights to set realistic goals and make well-informed decisions that span product development, market expansion and resource allocation, driving long-term success.
- Performance Measurement: A valuation provides a quantifiable measure of your startup’s performance, translating effort into measurable value. This perspective encourages a strategic mindset, helping you to focus your actions on generating sustainable growth and market relevance.
- Benchmarking: Valuation enables strategic comparisons with others in your industry, aiding pricing tactics, talent attraction, and solidifying your startup’s position in the marketplace.
The Startup Valuation Toolkit
1. The Berkus Method
The Berkus Method simplifies the startup valuation process for early-stage companies without substantial financial data to rely on, assessing five key elements with assigned monetary values: concept strength, prototype existence, team quality, strategic partnerships, and revenue progress.
Here’s how it could work in practice:
Imagine you’re the founder of a startup with an energy-efficient home automation system:
- Sound Idea (£400,000): Your energy-saving idea is groundbreaking, and you believe it has the potential to disrupt the market.
- Prototype (£800,000): You’ve built a fully functional prototype of your system, showcasing its feasibility and capabilities.
- Quality Management Team (£900,000): Your team consists of industry experts with a proven track record in bringing tech products to market.
- Strategic Relationships (£1,000,000): You’ve secured partnerships with key players in the home automation industry, allowing you to access distribution channels and gain credibility.
- Product Rollout or Sales (£300,000): While you haven’t started generating significant revenue yet, you’re in discussions with potential early adopters, and initial orders are on the horizon.
By applying the Berkus Method to your startup, you arrive at a preliminary valuation of £3.4 million. This structured approach helps you communicate your startup’s potential value to potential investors, providing a clear breakdown of how you’ve arrived at this figure.
2. The Scorecard Valuation Method
The Scorecard Valuation Method offers a systematic approach to evaluating your startup’s potential worth by considering key factors, assigning weights to them, and calculating an overall score. Here are the key steps and factors involved:
- Select criteria relevant to your startup’s industry and stage, such as market opportunity, technology, team, and marketing.
- Allocate weights to each factor, prioritising their significance.
- Rate your startup’s performance on a scale of 1-5 for each factor.
- Multiply the scores you’ve assigned by the weights allocated, quantifying the relative strength of your startup.
- Total the weighted scores for an initial assessment of your startup’s value.
- Map the total score to a valuation range, considering historical data or industry benchmarks to determine a preliminary valuation figure.
Let’s take a look at an example:
You’re the founder of a startup focused on revolutionising the telemedicine industry. Applying the Scorecard Valuation Method, you assess several key factors:
- Market Opportunity (Score 4, Weight 40%): The telemedicine market is expanding rapidly, and your startup is positioned to capture a significant share.
- Technology (Score 5, Weight 30%): Your telehealth platform incorporates cutting-edge features, making it highly competitive.
- Team (Score 4, Weight 20%): Your leadership team consists of medical experts and tech industry veterans.
- Marketing Strategy (Score 4, Weight 10%): Your go-to-market plan is comprehensive and data-driven.
After performing the calculations, your startup receives an overall score of 4.1 out of 5. Based on industry benchmarks, this score corresponds to a preliminary valuation range of £4 million to £5 million.
Interested in diving deeper? Schedule a call with the Standard Ledger team to unlock further insights.
3. Market Comparables
When you’re unsure how to value something, a natural instinct is to see what similar items are worth. That’s the principle behind the Market Comparables method. This method involves assessing your startup’s value by comparing it to what similar companies have been valued at during their funding rounds, especially those in the same sector or geographical area.
- Identify Comparable Companies: Choose companies in your industry with a similar business model and stage of development as benchmarks.
- Gather Valuation Data: Collect data from public sources, private transactions, or industry reports to understand how similar companies are valued.
- Adjust for Differences: Modify the data to account for variations between your startup and the comparables, like stage of development, size, location, or business model.
- Calculate Valuation Metrics: Compute relevant metrics like Price-to-Sales (P/S) or Price-to-Earnings (P/E) ratios for the comparable companies.
- Apply Comparable Metrics: Use these metrics to estimate your startup’s value, aligning it with comparable companies for a reasonable valuation.
Applying this to a real-world scenario:
Imagine you’re the founder of a green tech startup, and you want to determine its valuation. Here’s how you can apply the Market Comparables approach:
- Comparable Company A: A regional green tech startup raised £3 million recently, but it’s larger in team size and market presence than yours.
- Comparable Company B: Another green tech firm secured a £2.2 million valuation, similar in size and market positioning to your startup.
- Comparable Company C: A direct competitor raised £2.5 million, operating in the same area and stage as your startup.
You adjust for the differences, and take into account the potential value of your unique patent-pending technology, you arrive at a preliminary valuation of £2.7 million for your startup, making a compelling case to investors within the context of real-market data.
The Bottom Line
In the world of startup valuation, there’s no one-size-fits-all approach. It’s a mix of art and science, intuition and metrics. Each valuation method we’ve explored brings its unique strengths and limitations to the table.
The Berkus Method may offer a structured approach, but it risks oversimplification and reliance on subjective judgements. The Scorecard Valuation Method, while systematic, demands careful selection and weighting of factors, also introducing a hint of subjectivity. As for Market Comparables, its foundation in real-world data can sometimes be challenging to apply, especially in the absence of comparable companies.
However, combining these methods can help you to gain a more comprehensive understanding of your startup’s value. By triangulating the results, you’ll not only be better equipped to estimate your startup’s value accurately, but you’ll also be in a stronger position to justify that valuation to potential investors. And remember, valuation is not an exact science; it’s an ongoing process that evolves as your company grows and changes. Whether you’re seeking investment, negotiating with stakeholders, or making strategic decisions, a nuanced understanding of valuation will be a valuable tool in guiding your startup toward success.
Ready to dive deeper into your startup’s story and see where the next chapter could take you? At Standard Ledger, we specialise in assisting startups with their valuation challenges. Whether you’re diving into a funding round, sketching out growth plans, or making investment decisions, schedule a free chat with us and let’s map out your journey to a valuation that truly reflects your startup’s potential.
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