Valuing a Pre-Revenue Start-Up: A Comparison of the Berkus Method and Scorecard Method

Fictional Start-up Example: XYZ Tech

XYZ Tech is a pre-revenue start-up that has developed a new software product aimed at the education sector. The company has a team of six employees, including two software developers, a marketing specialist, a project manager, a financial controller, and a CEO. The company has raised $500,000 in seed funding from angel investors, and the founders are looking to raise a further $2 million in a Series A funding round.

Berkus Model Valuation

The Berkus Model is a valuation method that assigns a monetary value to a start-up based on five key factors: sound idea, prototype, quality of the management team, strategic relationships, and early market feedback. Each factor is given a value between $0 and $500,000, and the total is added up to give the start-up's valuation.

1.     Sound Idea: The first step in the Berkus Model is to evaluate the soundness of the company's idea. XYZ Tech's software product is aimed at a growing market, and there is no direct competition. This factor is valued at $250,000.

2.     Prototype: The next factor is the quality of the prototype. XYZ Tech has developed a functional prototype of its software product, which has been tested and refined through a beta testing programme. This factor is valued at $250,000.

3.     Quality of Management Team: The third factor is the quality of the management team. XYZ Tech has a CEO with a strong background in the technology sector and a team of experienced professionals. This factor is valued at $500,000.

4.     Strategic Relationships: The fourth factor is the company's strategic relationships. XYZ Tech has formed partnerships with several educational institutions, which will help to promote and distribute its product. This factor is valued at $250,000.

5.     Early Market Feedback: The final factor is early market feedback. XYZ Tech has received positive feedback from beta testers and potential customers. This factor is valued at $250,000.

The total valuation using the Berkus Model is calculated as follows:

Sound Idea ($250,000) + Prototype ($250,000) + Quality of Management Team ($500,000) + Strategic Relationships ($250,000) + Early Market Feedback ($250,000) = $1,500,000

Scorecard Method Valuation

The Scorecard Method is a valuation method that compares a start-up to a group of comparable companies and assigns a score to various factors such as the management team, product, market, and financials. Each factor is given a weighting, and the total score is used to determine the start-up's valuation.

1.     Management Team: The first factor is the quality of the management team. XYZ Tech's CEO has previous experience in the technology sector and has successfully launched products in the past. This factor is given a weighting of 25% and is scored as above average.

2.     Product/Technology: The next factor is the quality of the product/technology. XYZ Tech's software product is innovative and has the potential to disrupt the education sector. This factor is given a weighting of 30% and is scored as above average.

3.     Market: The third factor is the market. XYZ Tech is targeting a growing market with no direct competition. This factor is given a weighting of 20% and is scored as excellent.

4.     Competition: The fourth factor is competition. While there is no direct competition, there may be indirect competition from existing education technology companies. This factor is given a weighting of 10% and is scored as average.

5.     Financials: The final factor is financials. As a pre-revenue start-up, XYZ Tech does not have any financial data to evaluate. This factor is given a weighting of 15% and is scored as not applicable.

The total score using the Scorecard Method is calculated as follows:

Management Team (25% x Above Average) + Product/Technology (30% x Above Average) + Market (20% x Excellent) + Competition (10% x Average) + Financials (15% x Not Applicable) = 83.5

To determine the valuation using the Scorecard Method, we need to compare the total score to a range of scores for comparable companies. Let's assume that the range for comparable companies is between 75 and 90. Based on XYZ Tech's score of 83.5, the valuation range would be between $1.5 million and $3 million.

Comparing Results and Discussion

The Berkus Model gave a valuation of $1.5 million, while the Scorecard Method gave a valuation range of $1.5 million to $3 million. The two methods produced similar results, with the Scorecard Method providing a wider valuation range due to its comparison to a group of comparable companies.

Valuation is often viewed as both an art and a science. While there are quantitative methods like the Berkus Model and Scorecard Method that use measurable factors to determine a start-up's valuation, there are also subjective factors such as market trends and investor sentiment that can affect the valuation. The quality of the management team, for example, can be difficult to quantify but can have a significant impact on the start-up's success.

During negotiations, it is important to recognise that valuation is not a precise science, and there may be a range of reasonable valuations depending on the method used and the perspective of the parties involved. It is also important to consider the potential for future growth and revenue when determining a start-up's valuation.

In this blog post, we used the Berkus Model and the Scorecard Method to value a pre-revenue start-up called XYZ Tech. While both methods produced similar results, the Scorecard Method provided a wider valuation range due to its comparison to a group of comparable companies. We also discussed the subjective nature of valuation and the importance of considering future growth potential during term sheet negotiations. Valuation is an important part of the funding process for start-ups, and understanding the various methods and factors involved can help founders and investors make informed decisions.