The Importance of Business Appraisals to Pre-Revenue Companies
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Knowing and understanding your startup’s worth is essential to raising capital and seeking investment. But how do you truly understand where your startup is and where it’s projected to go? Business valuations provide the key to understanding this crucial information.
Learn more about the importance of business valuations for startups with our comprehensive blog category page on business valuations for startups.
How Does a Business Valuation Benefit Your Startup?
Pre-revenue business valuation is an essential event for owners and investors alike. For the company’s owners, a startup business appraisal will show how much the company can raise. For potential investors, a startup business valuation will demonstrate a company’s growth potential and the amount of equity it can receive.
Many investors will desire a higher projected value, as investing in startups often results in equity ownership. However, it is important not to over-inflate a pre-revenue valuation in anticipation of this. Keeping projections realistic will help avoid over-promising and under-delivering to investors. It is important to balance showing the highest value of your business possible while maintaining the most accurate value.
Please read valuing startup equity.
A Realistic Company Valuation
A realistic, comprehensive company valuation will help investors determine whether your company is a good fit for them and help your startup secure the investment and funding it needs. Knowing your startup’s projected value will arm you with the tools needed to grow it successfully and maintain preparation for any financial event.
Learn more with our guide on everything you need to know when valuing a pre-revenue startup.
How Does Valuing Startups Differ from Valuing Established Businesses?
When business valuations are performed for well-established businesses, the process is backed up by strongly established financial data. When valuing startups, this history of financial data is not yet present in the early stages of business. Because of this key difference, valuing startups will involve deep-diving into the factors determining a startup’s likelihood of success.
Please read how to value a company for investors.
Valuing startups is a process that is even more highly nuanced than a traditional business valuation, and determining the most accurate value possible requires a delicate hand. As many say, business valuations are more of an art than a science, and startup valuation methods are no exception to this rule.
At Business Appraisal FL|GA|HI, all our business evaluators are accredited in business valuations. They are Certified Valuation Analysts (CVA), and we are fully qualified to help you find the most precise value of your company. Many of us have built our own companies ourselves, and we understand the unique circumstances that your startup brings.
Know the benefits of business valuation services with our article on the top 7 benefits of getting a business valuation.
What Factors Influence Startup Valuations?
When a company is pre-revenue and has no financial history on which to base the valuation, other measurable factors create a picture of a business’s pre-money valuation. Some of these factors can include:
- Founder experience
When the startup’s founders or management have already proven themselves in other business ventures, this experienced background increases the likelihood of the new startup’s success, further increasing its value.
- Level of development
How far along in development is the startup’s product? From simply an idea to a fully developed product, the level of how much can be shown for a product can increase the startup’s credibility and the investor’s confidence in success.
Learn more about how to value your business.
- Market size
Larger markets result in a larger profit potential. So, the larger the market a startup is entering, the larger the startup can be projected to grow.
- Potential for industry disruption
In a market saturated with the same types of businesses, there is little more valuable than innovation and disruption. In addition, the potential of a startup to bring something truly unique to the world and disrupt current market control will show a higher projected value.
Is your business based in Florida or Georgia? Read our article about why now is the time to get a business valuation in Florida or Georgia.
What Methods of Valuation Are Suited to Startups?
Thanks to the unique challenges and situations that valuing startups brings, there are often different valuation approaches recommended than the methods traditionally associated with business appraisals.
- Berkus Method
Developed by an angel investor named Dave Berkus, the Berkus method is a simple method based on qualitative data. Examining five essential areas of a startup, a value ranging from zero to $500,000 is determined for each area. These five areas are:
Business Idea – The company has a sound business idea or business model.
Quality Management Team – The company is run by an exceptional, credible management team.
Product Rollout – The company shows a strong path toward revenue growth.
Strategic Relationships – The company has strong business relationships.
Prototype – The company has a developed product or prototype, which is the value of IP or intangible assets.
Because the maximum amount for each area is $500,000, the maximum startup valuation with the Berkus method is $2.5 million. This method often expects a projected value of $20 million in the 5th year of business, so once the original value has been assessed, it can be determined if the startup is likely to reach this goal.
- Risk Factor Summation Method
The risk factor summation method will consider several risk factors for pre-revenue startups. The most common types of risks include:
- Stage of business
- Management
- Funding risk
- Capital risk
- Burn rate or cash flow risk
- Technology risk
- Competition risk and strategic relationships risk
- Political risk
- Legislation risk
- International risk
- Potential lucrative exit
- Reputation risk
- Marketing risk
An investor will assess the risks of your pre-revenue startup using this guideline:
-2: very negative, subtract $500,00
-1: negative, subtract $250,000
0: neutral, $0
+1: positive, add $250,000
+2: very positive, add $500,000
By analyzing pre-revenue companies with this method, investors can understand the potential risks and rewards and determine whether the start-up fits their investment.
- Comparable Transactions Method
The comparable transactions method involves comparing your startup to similar startups that are further along on their path and asking how much it would cost to acquire these similar companies.
The valuation number for this method will be produced by determining revenue multiples for comparable businesses in the same industry as yours. If a comparable company with similar assets produces 6x to 8x more than the prior year’s sales, you may assume that your business’ revenue multiple will go a similar route.
Looking to value a small business? Read our article on what you need to know about small business valuations.
Business Valuations for Startups
Ready to know the true projected value of your startup? Reach out to BA FL|GA|HI today for a free, confidential consultation with our valuation experts to discuss your situation, the valuation process, the methods of valuation, and if our business appraisal services are right for you.