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:
1) Calculate the pre-revenue pre-money startup valuations in your area.
This involves researching the average valuation of all pre-revenue startups in your country, which is a difficult value to find. Based on the last available median US value, you can estimate how the proportionate valuation in your area are.
OUR MODIFIED METHOD
The country certainly plays a role in influencing the size of seed stage valuations, but the sector, in many cases, can be just as important, or even the most important factor for comparability. Therefore, researching seed stage rounds of funding would produce the most comparable pre-revenue pre-money valuation to apply this method correctly. In this case, it is very important that the chosen companies are truly at the same stage of the startup to be valued. In some cases, we are lucky to find the valuation of companies in the context of these transactions, but when these are not available, we can use the funding amount, which is also a very important figure. When the funding size is large, we can assume that the valuation also is, just as when the amount of funding is very low, the valuation will likely be low as well. To derive a value, we can use the rule of thumb stake value of 12.5%, which comes from observation and experience in seed stage transaction, except in cases where this value appears unrealistic. We can then estimate the median or average pre-revenue pre-money valuation.
2) Then attribute a value between -2 (for negative characteristics) and +2 (for positive characteristics or absence of risk) for each of these risks, compared to the seed companies analysed. Then you sum up the points and for every point you add or subtract $250.000.
Every point is valued at + or – $250.000. However, this method was conceived at a time when seed stage valuations were different. It is also not dynamic, as it must be adapted in case seed stage valuations are much lower or higher than the average.
OUR MODIFIED METHOD
This value should be preferably adjusted to the different valuation level, and currency, if the used currency is not USD. As comparison, we can use the estimated average seed stage value in point n°1, and compare it to the average seed stage value in the US: in this case the value changes from $250k to €130k due to the lower average valuations in the sector. This proportion should then be applied to the value of 1 point to calculate the Factor Adjustment.
3) Add the Factor Adjustment to the average pre-revenue pre-money valuation to arrive at the estimated pre-money value of your company. You can now add the investment sought to arrive at the post-money valuation.