There are two valuation methodologies for early-stage startups - qualitative and quantitative.
Method #1: Qualitative Approach
All qualitative approaches are based on some sort of scorecard. Each scorecard has its own unique set of attributes. Every attribute has a monetary range assigned to it as well as a weight that signifies the importance of each attribute. The value of a startup, based on this scorecard, will be the sum of the weighted values of all of the attributes.
While this method is easy to use and requires no finance knowledge, it also, unfortunately, for a startup founder, has three issues.
- It is not specific to the startup’s business model
- It puts an artificial ceiling on the company’s valuation
- The investor decides how much each attribute is worth
Therefore, a founder has very little power over determining the valuation of his company if a scorecard methodology is used. We recommend using this methodology only if there is not enough data for a quantitative approach.
Let’s assume we have a scorecard with four attributes: product readiness, traction, track record, and market size. All attributes are equally important and are thus equally weighted. Further, the value for each attribute can range anywhere from $0 to $500K.
Thus, under this scorecard, the maximum company valuation can only be $2M.
Method #2: Quantitative Approach
This method allows you to assess the financial feasibility of your business plan and represents a more accurate value of your company. This is good news for you because as a founder, you want to give away just the right amount of equity for the amount of money that you are raising.
That said, the quantitative approach is more difficult because it is based on a financial forecast that needs to be created. In order to create your financial forecast, you need to figure out your pricing strategy, your go to market strategy, and your cost strategy for the next five years.
Once you develop your forecast and you determine how much money your company will be generating, you can then use a simplified version of a traditional valuation model, called the venture capital method, in order to figure out the value of those cash flows, or the value of your company.
To learn more about different valuation models and how the venture capital method works, we recommend you take Class # 3 - Valuation Models For Early Stage Startups.