Valuing a pre-revenue startup business can be a difficult task, particularly given the various variables that must be taken into account. Many factors go into researching and generating a pre-revenue business valuation, including industry conditions, the reputation and expertise of the executive staff, the size of their unfilled niche, and demand for an undisclosed commodity.
And after reviewing anything and using the most appropriate pre-revenue valuation calculations, you can bear in mind that the best thing you can get with your tech startup is an estimate.
What’s the Difference Between a Startup Valuation and a Mature Business Valuation?
Let’s begin with the fundamentals before learning about how to evaluate a pre-revenue tech startup. What is the concept of a startup valuation? The method of estimating the total worth of a new business is known as startup valuation. The processes employed in this approach are critical because they vary from those used in a sales business. Although company owners wish for a high valuation, pre-revenue buyers should settle for a lower valuation that seems to provide a higher return on investment (referred to as ROI).
How does a mature business valuation differ from a pre-revenue startup valuation?
A business valuation will rely on hard figures and facts, as the company has financial records and steady stream revenue to calculate the overall value of a business. The EBITDA formula, which computes the value of a company based on its profits before depreciation, taxation, amortization, and interest, is usually used in a professional business valuation by an approved Business Appraisal Florida team member. Since a pre-revenue corporation has no revenue, amortization, or earnings, pre-revenue businesses must rely on other important factors to decide the worth of their business.
Factors for Pre-Revenue Startup Valuation
Many owners of pre-revenue companies do not earn as much as they expected, and investors for these companies often have to spend more than they anticipated.
Here are a few important factors that go into a pre-revenue startup valuation:
Proof of Concept
One of the main indicators in the value of a startup company that doesn’t have any revenue is traction. You can get a better understanding of the business by taking a look at the four data points that make up a company’s proof of concept or feasibility:
Growth rate– how much your business has grown on a small budget. This is a great tool to show investors who will be looking for potential growth when you’ve received financial backing.
Marketing effectiveness– if you’re able to attract high-value customers without spending large amounts of money on advertising, you’ll have an easier time attracting investors when your company is in its pre-revenue stages.
The number of people using your product– if you already have customers, you are off to a great start. The more customers you have, the better.
Will They Pay?– It is one thing to say you love a new idea, but will consumers write you a check?
The more that you’re able to prove that your company has a secure grasp on all four of the above-listed concepts, the more investors will be impressed with your growth. Even while your company is in its pre-revenue stages, you’ll be able to provide proof that you have a scalable business idea. This adds value to your business.
Investors won’t want to spend their money on a team that doesn’t seem like they’re set for success. To ensure that investors are interested in investing in your tech startup, take a look to ensure your company team has the following traits:
- Diversity of Skills
Is your business’s support staff made up of professionals who have had success in other startup tech companies? Investors would be more involved in businesses with a few seasoned members on board rather than companies with a lot of first-timer tech venture pioneers.
Another way to ensure that your tech startup appears stable is to make sure that your startup team consists of a variation of skilled people with complementary skills. A computer programmer can’t do everything. Digital marketing, on the other hand, has a better chance of success with your tech startup if you have someone on your team with marketing skills who can communicate with the programmer.
Not only do you need to make sure that your company has a mixture of experienced people who have complementing skills, but you also need to do your best to find people that have the time to dedicate to getting the company off of the ground. People at startups work crazy long hours, and not everyone is at that point in their life anymore.
How Investors Value Pre-Revenue Businesses
Taking a look at your business to complete a pre-revenue valuation on your own may seem daunting. To get an idea of the worth of your pre-revenue business, you can use the strategies of seasoned investors. Make an effort to become as acquainted as possible with these startup valuation approaches, as this will aid you in better understanding how to assess your business. Let’s look at the most popular approaches for valuing tech startups:
Popularized by Dave Berkus, a founding member of the Tech Coast Angels in Southern California, the Berkus Method takes a look at five important aspects of a startup business. They include:
|Characteristic||Add to Pre-Money Valuation|
|Quality Management Team||Zero to $0.5 million|
|Sound Idea||Zero to $0.5 million|
|Working Prototype||Zero to $0.5 million|
|Quality Board of Directors||Zero to $0.5 million|
|Product Rollout or Sales||Zero to $0.5 million|
Risk Factor Summation Method
Used most commonly with tech startup companies. Each aspect of a company is provided with a rating that’s up to $500,000. That means that the highest valuation that a tech company could receive is $2.5 million. This pre-revenue valuation method takes a detailed look at the risks that are involved with a company launching. Here are some of the risks that are looked at:
- Stage of business
- Funding risk
- Capital risk
- Technology risk
- Competition risk
- Political risk
- Legislation risk
- International risk
- Potential lucrative exit
- Reputation risk
- Marketing risk
An investor will go through and value the risk areas of your pre-revenue startup as such:
-2: very negative, -$500,00
-1: negative, the risk for carrying out a successful startup, -$250,000
0: neutral, $0
+1: positive, +$250,000
+2: positive for starting up and carrying out a successful business, +$500,000
If you’re concerned about the risk that your tech startup may be facing, the Risk Factor Summation Method can help to easily open your eyes to the value of your pre-revenue tech startup.
Common Mistakes When Valuing a Startup Company
It’s easy to make a few mistakes while you’re looking into how to value your company. Here are the most common mistakes that you can easily make (and avoid) while valuing your company:
Valuations Aren’t Permanent
A tech startup company is only worth what investors are willing to pay at a specific point in time. While as the owner of a business, you most likely aren’t going to agree with every valuation that your startup company receives. You must always keep in mind that no valuation, whether it be low or high, is ever permanent (or correct).
Valuations Aren’t Always Straightforward
Just because an investor is interested in your business doesn’t mean you and the investor agree on everything. When you have a pre-revenue startup valuation that you are happy with, it’s a smart idea to speak to your partners to make sure that everyone is on the same page about how you can proceed.
Preparing for a Pre-Revenue Evaluation
To provide yourself with the highest valuation for your pre-revenue business, you must weigh all of the aspects that your tech startup has to deliver. It’s also important that you, as the business owner, learn how to measure the worth of your company before approaching others who may be interested in investing in it. Experimenting with a variety of valuation approaches would enable you to demonstrate to your investors that your business has the potential to expand and is worth their investment.