How do you value an early stage company?

We are often asked, how do you value an early stage company? Valuation of seed stage companies is part art and part science. There are four generally accepted means of attempting to determine value:

Dave Berkus Method – Berkus is a long-time angel investor in Southern California. His method gives a company credit for achieving certain milestones. The maximum valuation of a company using this method is $2.5m.

Scorecard Method – The Scorecard Method is very popular with Angel Groups in the US. The challenge for using this in Central Europe is its dependence on comparative data. In Silicon Valley, there is a great deal of information on Angel / Seed deals that make this method work. For example,

  • Center for Venture Research’s The Angel Investor Market in 2012

  • Fenwick and West’s Seed Financing Survey 2012 of Internet/Digital Media and Software Industries

  • Angel Resource Institute’s 2012 Halo Report (produced in cooperation with Silicon Valley Bank 2012 Halo Report)

Your concern should be that similar data is not available making the Scorecard Method less viable.

Risk Factor Summation Method – This method is similar to the scorecard method and is perhaps more comprehensive in the factors it considers. It is considered flawed by some because the factors are all equally weighted.

Venture Capital Method – First proposed by Professor Bill Sahlman at Harvard Business School in the 1980s (HBS Case #: 288006-PDF-ENG). This method is somewhat challenging to use with very early stage companies since it relies on predicting how much a company will sell for in 5-8 year. Although, for later stage companies, this method can be useful.

Most seed or Angel investors use a hybrid of at least 2 of these four methods to determine a valuation. I believe that that combination of the Berkus and Risk Factor methods would be a good starting point for a methodology to use to evaluate your own company.

Oversight Process

In general, seed stage investors require monthly status reports on the financial performance of the portfolio and progress against milestones. These are reviewed either on the phone or in person. Investors may also require an approval process for hiring and contract signings.

There are two likely investment methods, based on US models

  1. Convertible note

  2. Preferred participating stock

You will need to think about which method is most appropriate for you – and what the investor wants to use. In general, the earlier the company is in its development cycle, the more likely a convertible note will be appropriate because it is far cheaper to implement and defers the question of valuing a company.