Pre-revenue startups are different because they do not have a proven revenue record. That makes it difficult to value the company accurately.

Even after the best formulas and metrics are used, the value of a pre-revenue startup is still predominantly based on subjective factors and intangible assets. However, it’s not impossible to value pre-revenue startups. Below, we explain the valuation methods and approaches for an early-stage startup.

How Does Pre-Revenue Valuation Differ From Valuing Established Companies?

Valuing a pre-revenue startup is different from valuing an established company. A mature company will have more data and hard facts to work with. It will also have a history of revenue and profit or loss, cash flow, and customer patterns to consider, allowing you to use more traditional financial metrics.

Established businesses normally use the EBITDA formula to calculate enterprise value and the price-earnings ratio to compare market values to earnings. However, these metrics are not suitable for pre-revenue businesses. Here’s the formula for EBITDA:

EBITDA = Net Profit + Depreciation + Amortization + Interest + Taxes

A company without revenue won’t have net profit or taxes to factor in. Plus, there’ll  be no detail on amortization for such a company to use in the valuation process.

Factors to Consider for Pre-Revenue Startup Valuation

Here are a few factors you should consider when valuing a pre-revenue startup.

Traction Acts As Proof of Concept

For a business with no revenue, traction can be used as proof of concept. Having customers or people using your product (through a beta test) is one way to show potential investors or acquirers that your concept is viable and worth investing in.

Here are some options:

• Growth rate
• Marketing effectiveness
• Number of users
• Level of engagement

These metrics offer an indication of the potential success that a startup will have when it has revenue.

Supply and Demand

In a business landscape where your business is in high demand, you can expect a higher valuation and investor interest. Suppose you’re a fintech startup catering to the small business market. Investing in this sector is attractive due to its potential and growing demand.

On the other hand, if you’re in a highly saturated market, the valuation of your startup might be lower than expected. An example of this might be a messaging app with little or no unique features compared to the competition.

Founding Team

The strength of the founding team is important to consider when valuing a pre-revenue startup. Investors and acquirers are looking for founders with experience in the industry and business acumen that demonstrates the startup’s potential for success.

A strong founding team will have complementary skills, such as:

• Business development
• Product development
• Marketing
• Sales
• Technical expertise

Prototypes

A prototype product can increase your startup’s valuation significantly even if you do not have any revenue. Having an actual working prototype shows potential investors and partners that you are serious about the product.

Add a Minimum Viable Product, and your valuation can increase even further. A Minimum Viable Product (MVP) is an early version of your product with just enough features to satisfy early customers and provide feedback for product development.

Methods to Value Pre-Revenue Companies

Although it’s a bit tricky, there are a few approaches available to value pre-revenue companies. Here are some of them.

Berkus Method

Dave Berkus, an angel investor, is credited with developing one of the most popular methods for valuing pre-revenue companies. The Berkus Method involves looking at the following five business aspects:

• Prototype
• Concept
• Connections
• Launch Plan
• Quality Management

Every aspect can have a maximum value of $500,000. So, the highest value a company can achieve using the Berkus Method is $2.5 million.

Venture Capital Method

The Venture Capital method was popularized by Bill Sahlman, a professor at the Harvard Business School. It has two steps:

• First, the company’s expected return rate must be determined. It can be done by looking at similar companies that have been funded by venture capital firms.
• Second, the investors track backward to determine the value of the company. They consider the size of the investment, company growth rate, and estimation of investors’ return rate.

To calculate the terminal value, you’ll need the following:

• Industry P/E ratio
• Projected revenue for the harvest year
• Projected profit margin for the harvest year

Then, you can use this formula to get the terminal value:

Terminal Value = projected revenue * projected margin * P/E

Once you have the terminal value, you can use this formula to calculate the pre-money valuation:

Pre-Money Valuation = Terminal value / ROI – Investment amount

Cost to Duplicate Method

The cost-to-duplicate method assesses a startup’s value based on the costs associated with recreating its assets. To calculate the company’s value, you’ll need to consider factors like market research, intellectual property, and software.

This method determines the company’s value by summing up the costs associated with duplicating its assets. The downside of the cost-to-duplicate method is that it doesn’t consider intangible assets like brand value and market trends.

Combo Platter Method

The Combo Platter method is a mixture of all the other methods. First, you have to devise three value tiers:

• Best-case scenario
• Moderate
• Worst-case scenario

After that, you use the Berkus and Risk Factor Summation methods to create a valuation range for the company and refine the estimated figures. Since this method considers multiple angles of the company, it is seen as one of the more accurate methods.

The final value is usually a range between the three tiers, which allows the buyer and seller to negotiate a fair price.

Present Your Pre-Revenue Valuation In a Financial Model

Pre-revenue startups have to create financial models to showcase to investors the potential of their business. Just like valuing a pre-revenue business is different from an established enterprise, creating a financial model for an early-stage startup is trickier.

That’s why it’s best if you let professionals like the ones at Numberly create a financial model that accurately presents your pre-revenue valuation. Since our financial models are customized and tailored to the specifics of your business, you’ll be able to tell your story to the investors in a compelling way. Schedule a call with us to discuss your plans in detail.