Framework for Pre-Revenue Startup Valuation

There's a few methods to do this, such as the scorecard method. Today, I will go over the Dave Berkus valuation method (DBM), which is a pretty straightforward method for valuing pre-revenue startup companies.

Essentially, Dave Berkus was an angel investor who examined why some companies failed over others and created a framework to assess common strengths and weaknesses of those companies. Its important to understand valuation methods such as this if your business is trying to obtain funding- you'll want to know what to address and what investors may be looking for. You might also want to use this to assess if your business idea is worth pursuing.

The framework is pretty straightforward. There are 5 factors:

• Sound Idea (What problem are is being solved? How large is the addressable market? Is the proposed idea sufficiently distinct? How is the timing with respect to macro trends? Has the idea been validated? etc.)

• Quality Management Team (Does the team have relevant experience? Is this their first startup? What are their skill sets and how do they synergize? Is key person risk relevant? etc.)

• Prototype or Product (Is there a working prototype? Have users interacted with it? What’s the timeline to a usable or sellable product? Are there any unique innovations or defensible features? etc.)

• Strategic Relationships or Partnerships (Are there any signed partnerships? Do they have any strategic advisors or mentors? Are there any relationships that give the team access to distribution, IP, or talent? etc.)

• Product Rollout or Sales (What is the go-to-market strategy? How does the team plan to scale sales (direct, partnerships, digital)? Has the team tested pricing, channels, or customer acquisition strategies? etc.)

Each factor is assigned a value up to $500k, for a total project value capped at $2.5 million. You could also switch those out for scaled scores attached to some budget based on risk capacity and tolerance, though you should be aware that angel investing has clear and significant risks (you will probably want to be able to spread those risks across investment opportunities).

What are some of the strengths of the DBM?

• Its simple, easy to use, and gives a quick estimate of the investment opportunity.

• It can be used absent of revenues.

• It focuses on risk reduction and places a cap on the value to help mitigate overvaluation.

• The DBM uses multiple factors and provides guidance as to what angel investors could focus on, as opposed to simply a good idea or a strong management team.

What are some of the weaknesses of the DBM?

• Obviously, its subjective, though you'll be unlikely to rely on useful objective criteria to assess at the pre-revenue stage (and using the DBM should include industry growth and margins for example).

• Some companies may be undervalued (but due to the risk discussion above, this is likely the lesser evil).

• Once companies start generating revenue, other valuation methods should be used.

• The method, as is, should be adjusted for inflation, industry norms, and so on.

What variations on the DBM are available?

• Additional factors: competitive advantage (though you should probably consider that in sound idea or product); tech scalability (tech companies sometimes have explosive growth, which is why venture capitalists focus on them; additionally AI has made small teams quite effective, so the ability to integrate tech for scale is important)

• Geographic adjustments for valuations (Silicon valley tends to harbor greater valuations than emerging markets)

• Add weights to the factors (rather than weighing them equally, you may believe that management quality is more important than a sound idea)

• Sector specific adjustments for more particular factors (for example, in biotech you may want to look at novelty, patents, and support available, among other things)

• As mentioned previously, you can also use scaled factors instead of an amount of money allocated but you should probably be reasonable when investing

That's all.

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