How to value a startup with no revenue? (Ultimate guide to value a startup)

So you must be thinking why value a startup with no revenue? When Facebook bought Instagram, it had no revenue. But still, Facebook thought it was worth pouring a billion dollars on it. How can a company with no revenue be worth a billion dollars?

In this article, we’ll learn about ways to value a startup with no revenue.

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What is a Pre-revenue startup?

As the name suggests pre-revenue startups are startups that don’t have any revenue. This may be because they don’t have a product out in the market yet or they are in their early stages.

What is Startup valuation?

Startup valuation is determining the worth of a startup. A startup has various investors that fund it in exchange for equity.
It’s easier to calculate the valuation of a publicly listed business as they have more strong figures and financial records to go on. The valuation is commonly calculated using the EBITDA formula.

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

Since we don’t have these figures for a pre-revenue startup, finding its valuation can be a tall order.

Why is it important?

  • Most importantly, it decides the equity entrepreneurs have to give to investors in exchange for funds. For eg – If the valuation of a startup is high, they need to give fewer shares in exchange for seed investment
  • Moreover, the valuation of a startup may not be the same for all investors. 
  • It also impacts your demand and reliability in the market. This can have a major effect on hiring, drawing other investors, your customers, how much they’ll pay and recruiting advisers.

Methods of valuation

Now let’s look at the most awaited topic in the article – the methods used to value a startup with no revenue

1. Berkus Method

This method was invented by Dave Berkus. It had been refined over the years to take into account other factors of the present time like inflation. This method was last changed in 2016. It also assumes that the startup will earn $20 million in 5 years.

These are the elements that are taken into account –

  • Concept
  • Prototype
  • Quality management
  • Strategic relationships 
  • Launch plan

All factors contribute a maximum of $500,000. So the max valuation can be $2.5 million. You then add all the assigned values to get the valuation.

This method does not take the market into consideration, which can be an important element for many investors.

2. Venture Capital Method

Professor Bill Sahlman of Harvard Business School came up with this method. It is the most important method. As the name implies, it is used by VCs. 

Here we go backward. This method calculates the pre-money valuation by first determining the post-money valuation. There are 2 important equations here.

  • Post-money valuation = Terminal value ÷ Expected Return on Investment (ROI)
  • Pre-money valuation = Post-money valuation — Investment

To calculate this we find the average sales of established companies in the same sector and multiply it by 2. Also, be aware that inflation is also taken into account here. For eg you are raising $500,000 and anticipate generating $10 million in 5 years, the terminal value would be 

Terminal value = $10 million * 2 = $20 million

Moving on to ROI, you need to make another assumption. Since early-stage startups are risky, ROI can be 10-20x. In our case, let’s assume it’s 10x.

Post-money valuation = $20 million ÷ 10 = $2 million
Pre-money valuation = $2M — $500K = $1.5M

You can also calculate the VCs ownership by dividing the investment value with post-money valuation. In our case its $500,000/$2 million = 25%

Scorecard Valuation

This method is also called the Bill Payne valuation method and is widely used by angel investors.

I hope you guys have watched silicon valley(if you haven’t please do, awesome series). In this series Richard(the protagonist) is forced to sell a server box instead of his platform because his platform had no value then. Later Gavin Belson (CEO of a huge tech company) buys the platform from a competitor company for a very high price. Hence Gavin puts a value on the platform and Richard is allowed to start working on the platform. 🙂 happy ending
We do the same thing here, startups are compared to other funded pre-revenue startups. We modify the average valuation based on factors like the team, product, region, etc.

The first step here is to calculate the average valuation of pre-funded startups in the same marketplace. I would recommend  AngelList here. It is a great resource to analyze valuation data for thousands of startups.

The next step is to find the below values, by comparing how your startups stack up against others in the same marketplace

  • Strength of the Management Team (0–30%)
  • Size of the Opportunity (0–25%)
  • Product/Technology (0–15%)
  • Competitive Environment (0–10%)
  • Marketing/Sales Channels/Partnerships (0–10%)
  • Need for Additional Investment (0–5%)
  • Other (0–5%)

As you can see, major significance is given to the team here. So hiring is good team is extremely crucial to a business. You can read more about how to find developers for your startup here.

In building a business, the quality of the team is paramount to success. A great team will fix early product flaws, but the reverse is not true.

Bill Payne
FactorRangeTarget CompanyRange*Target Company
Strength of the management team30%120%0.36
Size of the opportunity25%140%0.35
Competitive Environment10%70%0.07
Marketing/Sales Channel/Partnerships10%70%0.07
Need for additional investment5%100%0.05
Other factors5%100%0.05

Next, you take this sum and multiply it with the average valuation of startups calculated in the first step. Let’s assume it’s $2 million. Pre-money valuation = 1.1 * $2 million = $2.2 million.

Risk Factor Summation Method

As the name implies, we sum risks of various important factors. How do we do it and what are the factors? Let’s see

  • Management
  • Stage of the business
  • Funding/capital risk
  • Manufacturing risk
  • Technology risk
  • Sales and marketing risk
  • Competition risk
  • Legislation/political risk
  • Litigation risk
  • International risk
  • Reputation risk
  • Potential lucrative exit

There are 5 scores given to each of these factors

  1. -2 – very negative
  2. -1 – negative
  3. 0 – neutral
  4. 1 – positive
  5. 2 – very positive

Here the valuation increases by $250,000 for every +1, $500,000 for every +2, and similarly decreases by $250,000 for every -1, $500,000 for every -2.

How to value a startup with negative income?

This is actually a very good question. Now you must be wondering how can income be negative? Well, this means that the spending is greater than the profits. This can be temporary or permanent. Early-stage startups usually begin their journey with negative cash flow.

Temporary causes can affect one company – for eg some interruption at the main production facility – or the entire sector, for eg – movie ticket booking apps had to face huge losses during lockdown

Permanent issues can lead to pivots, due to changing customer demand, an example is blackberry’s dramatic shift from smartphones to a cybersecurity company due to the increasing popularity of Apple and Samsung smartphones.

Now coming to the valuation methods –  discounted cash flow (DCF) or relative valuation are some methods that can be used to value negative income startups.

Final thoughts on valuing a startup with no revenue

So there we have a list of methods to value a startup with no revenue. There’s even an online calculator but do not completely rely on it.

No single startup valuation technique gives you an accurate value. You need to combine and experiment with various methods to find the true value. Also, a valuation is not permanent. Different investors have different views. You may not receive the valuation you expected but no worries, try another investor.

I hope you learned something new from the article. Let me know in the comments below what your startup is worth?

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