The Berkus & Risk Factor Summation Pre-Money Valuation Methods Explained

So far we have covered in the Scorecard Valuation Method and the Venture Capital (VC) Valuation Method for providing an adequate pre-money valuation for pre-revenue startups. These two valuation methods are most widely used by Angel Investors for pre-revenue startups when determining seed investing and subsequent financing rounds. I am a diehard fan of the Scorecard Valuation Method to ascertain a fair, workable pre-money valuation for early stage startups. Bill Payne, top US Angel Investor who has fast become my go-to valuation guru, shares several other pre-money valuations that are much more supplemental to the Scorecard and VC methods. Two of these are the Berkus Valuation Method and the Risk Factor Summation Valuation Method.

#1 Berkus Valuation Method

The Berkus Valuation Method is a construct of SoCal’s Tech Coast Angels co-founder, Dave Berkus. On one hand, the criteria is much easier to handle than the Venture Capital Method. On the other hand, the parameters are very broad, and would take a great deal of negotiation. The criteria, taken directly from Bill Payne’s explanation, are as follows:

Where, the monetary sum of the characteristics equals the base pre-money valuation. So, we can end up with a pre-money valuation of 0€ or 2.5 million€ based on the amounts chosen. If an Angel or entrepreneur were to use this as a stand-alone valuation, it would take a very strong knowledge of pre-money valuations of early stage startup peers per industry, as there is no quantitative factor, multiple or historic performance number to work from. We consider the Berkus method to be a good supplement to the Venture Capital Method of pre-money valuation. Why? The Venture Capital Method focuses heavily on industry quantitative data, and tends to forego the qualitative factors mentioned in the criteria above. As well, Bill Payne mentions that this particular method works best for the earliest stages of startup formation, where financial projections just do not make sense. It gives the broadest idea of a pre-money valuation for the startup at inception.

#2 Risk Factor Summation Method

The Risk Factor Summation Method has a bit more quantitative workings on specific risk factors, which brings further risk management and governance consideration into the pre-money valuation. I personally like this valuation method paired with the Scorecard Valuation Method for comparison.

1. Like the Scorecard Valuation Method, we need to start with the average industry pre-money valuation. Let us chose the same scenario used in our previous Scorecard Valuation example – a tech pre-revenue startup, where the average industry pre-money valuation is 1.5 million€.
2. We are going to address a list of risks associated with the startup and it’s industry:
   1. Management risk
   2. Stage of the business
   3. Legislation/Political risk
   4. Manufacturing risk (or supply chain risk)
   5. Sales and marketing risk
   6. Funding/capital raising risk
   7. Competition risk
   8. Technology risk
   9. Litigation risk
   10. International risk
   11. Reputation risk
   12. Exit value risk
3.  Instead of assigning percentage weights and multiples, we assign the following ratings to each risk factor and do an adjustment to the average pre-money valuation per each rating:

Let’s do an example. The tech startup has a very strong management team, a well developed prototype, with increasing traction focusing on the local market in inception. The barriers to market entry are not high, however. The market is not highly regulated, and the geography for growth is politically stable. The startup has developed a strong strategic partnership with a large corporate partner that may be a suitable acquirer in three to five years.

• Average Industry Pre-Money Valuation: 1,500,000.00€
  • Adjustment: 250,000€
• Tech startup pre-money valuation: 1,500,000€ + 250,000€ = 1,750,000€

As we can see, even though the risk factor summation seems complicated, it yielded close to the same result as the prior example in our Scorecard Valuation Method example, which was a pre-money valuation of 1.7 million€. So, many of these valuation methodologies can yield close to the same result once there is a strong knowledge of industry trends and startup capabilities.

Again, a qualified opinion will be necessary. However, doing a pre-money valuation for startups before engaging an Angel or even a strategic partner can work wonders for internal preparation and negotiation.

 

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