The selection of an appropriate valuation approach in the ever-transforming startup world is essential not only for successful fundraising but also for achieving positive long-term growth. This blog will outline the most effective methods to determine the value of a pre-revenue startup and ensure you use the right one to set realistic expectations and attract potential investors.
What is pre-revenue?
The term “pre-revenue” is composed of two words: “pre” and “revenue.” “Revenue” is the amount of money a business generates from the sale of its products and services, while “pre” means before.
In other words, the term “pre-revenue” refers to the fact that a business is not yet generating revenue. As such, the term is used to describe enterprises that have developed concrete business plans, prototypes, and products but have not yet generated revenue from customers.
What is pre-revenue valuation for startups?
Pre-revenue valuation is a critical activity for both the business proprietor and investors, as it quantifies the value of a startup. From the owner’s perspective, they can determine the amount of money they can raise. Investors will want to know how much equity they will get and the company’s growth and return on equity potential.
Investors frequently receive equity ownership as compensation for their investments in ventures. Consequently, they assess the value of their equity and the potential benefits they may derive from appraising the company. Typically, the objective is to achieve a higher valuation.
Conversely, proprietors must accurately assess their organization to prevent investors from placing excessive expectations. While an exaggerated evaluation may result in increased pre-revenue startup funding, it may also convey a negative impression of your business to existing and potential investors if you cannot meet these expectations.
Valuation Methods for Pre-Revenue Startups
Since startups in the pre-revenue phase have no past financial data, their value is calculated using other methods. Usually, these methods do not rely on historical financial performance but instead on factors such as quality, market comparisons, and future projections. Some of the most popular methods are as follows:
1. Berkus Method
The Berkus Method is a simplified approach to evaluating pre-revenue firms based on risk assessment. It assigns a monetary value of up to $500,000 to each of five critical success factors to estimate a startup’s valuation and account for key areas that reduce uncertainty. If a startup demonstrates strong performance across all five fronts, its valuation could reach a maximum of $2.5 million using this method.
The five success factors are:
- Sound Idea (fundamental value)
- Prototype (reducing technology risk)
- Quality Management Team: This process helps in minimizing the execution risk
- Strategic Relationships (reducing market risk)
- Product Rollout or Sales (Minimising production risk)
Valuing each factor could go as high as $500,000 if the startup manages to handle that specific risk well.
For example, a software startup, “Softease,” is evaluated as follows:
| Criteria | Assigned Value | Reason |
| Sound Idea | $300,000 | Innovative SaaS platform for remote teams |
| Prototype | $200,000 | Working beta version with core features |
| Quality Management Team | $400,000 | Experienced software engineers and leaders |
| Strategic Relationships | $150,000 | Early partnerships with coworking spaces |
| Product Rollout/Market Potential | $250,000 | Large and rapidly growing SaaS market |
Summing these up, the total value is $1.3 million. With this approach, the company’s value is estimated at present, i.e., before the revenue generation process begins.
2. Scorecard Method
The Scorecard Valuation Method is widely adopted by angel investors to ascertain the pre-money valuation of pre-revenue ventures. The procedure begins with an average pre-money valuation of similar startups in the area and stage, and adjustments are made up or down according to how the startup compares to peers in key aspects.
- Strength of the Management Team (30%)
- Size of the Opportunity/Market (25%)
- Product/Technology (15%)
- Competitive Environment (10%)
- Marketing/Sales/Partnerships (10%)
- Need for Additional Investment (5%)
- Other Factors (5%)
Each element receives a weight that reflects its relevance to the overall success of the startup. After that, the startup is rated in each category compared to similar companies (e.g., 125% for much better than average, 100% for average, and 75% for below average). The weighted scores are aggregated to determine a valuation adjustment relative to the benchmark.
For example, let’s say the average pre-money valuation for startups in your region is $4 million. After doing your research, you come up with the following scorecard for your startup:
| Factor | Weight | Startup Score (vs. benchmark) | Weighted Score |
| Management Team | 30% | 120% | 0.30 × 1.20 = 0.36 |
| Business Opportunity | 25% | 100% | 0.25 × 1.00 = 0.25 |
| Product/Technology | 15% | 110% | 0.15 × 1.10 = 0.165 |
| Competitive Environment | 10% | 90% | 0.10 × 0.90 = 0.09 |
| Existing Market | 10% | 100% | 0.10 × 1.00 = 0.10 |
| Investment/Partnerships | 5% | 100% | 0.05 × 1.00 = 0.05 |
| Other Factors | 5% | 100% | 0.05 × 1.00 = 0.05 |
| Total Score Multiplier | 1.065 |
Final Valuation: $4 million × 1.065 = $4.26 million.
3. Risk Factor Summation Method
The Risk Factor Summation Method looks at various factors to figure out the pre-money valuation of pre-revenue startups. It helps investors carefully assess different risks that might affect the company’s success and future exit. Typically, this method considers around a dozen types of risks, including:
- Management
- Stage of the business
- Legislation/political risk
- Manufacturing risk
- Sales and marketing risk
- Funding/capital risk
- Competition risk
- Technology risk
- Litigation risk
- International risk
- Reputation risk
- Potential lucrative exit
Each of these risks is assessed as follows:
+2 – very positive
+1- positive
0 – neutral
-1 – negative
-2 – very negative
After evaluating the risks, the method assigns a monetary adjustment to each one—either adding or subtracting value depending on the nature and severity of the risk. So,
- -2 (very negative) = subtract $500,000
- -1 (negative) = subtract 250,000
- 0 (neutral) = add/subtract nothing
- +1 (positive) = add $250,000
- +2 (very positive) = add $500,000
The average pre-money valuation of pre-revenue enterprises increases by $250,000 for every +1, or $500,000 for every +2. The pre-money valuation decreases by $250,000 for each -1 and $500,000 for each -2. The scorecard method can be employed to ascertain the average valuations in the market.
For instance, Brightpath Solutions, a manufacturing startup, has very good performance in terms of reputation, manufacturing, litigation, and marketing, but has a negative score in management risk, while competition risk is at a moderate level.
| Risk Factor | Rating | Adjustment |
| Reputation Risk | +2 (Very Positive) | +$500,000 |
| Manufacturing Risk | +2 (Very Positive) | +$500,000 |
| Litigation Risk | +2 (Very Positive) | +$500,000 |
| Marketing Risk | +2 (Very Positive) | +$500,000 |
| Management Risk | -2 (Very Negative) | -$500,000 |
| Competition Risk | +1 (Positive) | +$250,000 |
| Total Adjustment | $1,750,000 |
4. Venture Capital Method
The method is popular among investors when they need to assess early-stage startups that have no income yet.
The initial step for investors is to make a rough estimate of the company’s potential exit value, for example, through a sale or an IPO. This value generally comes from projecting the financials of the firm (i.e., income or EBITDA) at the time of sale and applying a standard multiple from the respective industry, derived from a group of similar companies or recent transactions.
Then they determine today’s valuation by calculating the return they want in the future. The figure can be considerably high—for instance, 10 times or more—as early-stage investments obviously carry considerable uncertainty.
After that, the post-money valuation is calculated by dividing the expected exit value by the target return rate. To get the pre-money valuation, investors simply subtract the amount they plan to invest from the post-money valuation.
For example, imagine a startup that predicts it will make $10 million in revenue a year from now. If startups from the same industry are usually bought out for 5 times their revenue, then in this case, the most likely exit value would be:
Exit Value = Projected Revenue in Year 5 × Industry Revenue Multiple
= $10,000,000 × 5 = $50,000,000
An investor seeking a 10x return would use this exit value to determine today’s valuation:
An investor looking for a 10x return would be up for putting in $2 million now.
Then, the post-money valuation = Exit Value ÷ Expected ROI
= $50,000,000 ÷ 10
= $5,000,000
Then, your pre-money valuation = Post-money valuation – Investment amount
= $5,000,000 – $2,000,000
= $3,000,000
So, by applying the Venture Capital Valuation Method, the present worth of the startup is approximately $3 million.
5. Cost-to-Duplicate Method
The cost-to-duplicate method calculates the value of a startup based on the exact price it would take to replicate the business at the current time. It covers things like equipment, inventory, and intellectual property, as long as the development costs can be measured. It doesn’t factor in brand value or any potential growth down the line.
To use this method, you start by listing the startup’s main assets, like hardware, equipment, software, and product design. Then, you figure out how much it would cost to build or buy them. The total cost gives you the startup’s value. The idea is that the company’s worth is how much it would take to start it from scratch.
For example, the hardware of a startup company has a value of $100,000, the software development costs are $150,000, and the value of the intellectual property is $50,000. By applying the cost-to-duplicate method, the total amount required to recreate the startup would be $300,000.
Additional Valuation Methods
You can also use methods like the Discounted Cash Flow (DCF) Method, the First Chicago Method, or the Comparable Method to value a startup before it earns revenue. These techniques work by looking at upcoming cash flow estimates, making decisions based on various scenarios, or comparing similar firms in the market.
Which Valuation Method Fits Your Pre-Revenue Startup?
Utilize this framework to promptly identify the most appropriate valuation method for your startup’s stage and the data you have at hand.
| Startup Situation | Best Valuation Methods | When to Use |
| Concept or Prototype Stage, No Revenue | Berkus Method | The early stage is when value is created by the team, the idea, and key milestones. |
| Initial Growth, Partial User/Market Data | Scorecard Method | There are several users of market signals; these can be compared with those from similar startups. |
| Reliable Financial Forecasts | DCF Method, VC Method, First Chicago Method | When you are predicting future cash flows, estimating exit values, or applying scenario analysis. |
| Available Benchmark Data | Comparable Transactions, Market Multiples | When new deals or user/revenue multiples have recently appeared in your industry. |
| Notable Tangible/IP Assets | Cost-to-Duplicate Method | Startups that rely on assets, advanced technology, or IP are valued based on the cost of replicating the company’s operations. |
| Elevated Risk and Uncertainty | Risk Factor Summation | Adjustments can then be made to the base valuation due to certain risks. |
Building a Strong Foundation with Accurate Valuation
Valuing a startup that is not yet generating revenue is a complex task that requires careful consideration and the right tools to ensure transparency and sound decision-making. By using proper valuation methods, founders can determine whether their expectations are realistic, attract the right investors, and lay a foundation for the company’s future growth.
For founders to face these difficulties adequately, Cheqly has partnered with Eqvista to offer trustworthy, IRS-compliant 409A valuation services aligned with your startup’s needs. Through this partnership, you can obtain accurate and defensible valuations for equity management and financing, along with Cheqly’s additional services such as business account opening, online transfers, physical and virtual debit cards, and venture debt. Contact us to learn more!