For a standard valuation, applying the market method means extracting multiples from comparable transactions or comparable stock-listed companies to estimate the current value of the company being valued. This cannot apply to seed stage startups for obvious reason:
- No stock-listed company can be comparable to a startup
- Multiples cannot be used at this stage as the company has little or no revenue, as well as few users, if any
- By comparable transactions in a standard valuation we usually mean mergers & acquisitions transactions that involve the sale of a majority shareholding. The multiples are then applied to the company’s current figures, assuming the company is ready to be sold in the near future. We can use this method to estimate a future exit value, but not to directly estimate the current value of a seed stage startup, as the company would not be an acquisition target today, in the vast majority of cases.
However, we can apply an adapted comparable transactions method to seed stage startups by using comparable rounds of funding. There are a few related methods that can be used and that we can call seed market methods. These are usually called rule of thumb methods as well, since these methods are simplified and some approximation is necessary due to the scarcity of data and the lack of complexity and therefore precision.
One advantage of these methods is that no financial plan is required, while one disadvantage is that some figures used can be subjective or are not based on or proportional to observed market values. Another advantage is that it can be used in new emerging sectors where sector exit information is not yet available.
A way to conduct a valuation at the pre-revenue stage, in the absence of reliable financial information or projections, is therefore to observe similar rounds of funding. These methods were originally developed by Bill Payne, and then adapted by Ohio Tech Angels.
The one that I find to be the most useful is the Risk Factor Summation Method, as it accounts for more risks and features compared to other seed stage valuation methods. Other methods that we will not discuss here are the Scorecard Valuation Method, the Dave Berkus Method and the Development Stage Valuation Approach.
How to use this method: