How to Calculate Your Pre-Seed Funding Valuation
How can I calculate the value of my pre-seed startup?
As an angel investor, I get this question a lot from founders struggling to put a concrete value behind their company at such an early stage. It’s understandable. There’s often little transparency in pre-seed valuation methods, and, while there are ways to calculate a close figure, it will always be an approximation.
Valuing your company too high can set impossible expectations while valuing it too low can lead to over-dilution early on. Finding the sweet spot is critical. Here are some of the most widely-used methods to calculate your pre-seed, pre-money funding valuation:
Compare to Similar Companies
A simple method that many pre-seed startups use is comparing their company to similar ones, much like a realtor looks at “comps” to assess the value of a home.
If you can identify a few startups with similarities to yours and learn what they’re valued at, it can give you a good idea of what range your startup would fall into. The more parallels between your company and theirs—such as sector, market size, or region—the more accurate the comps will be.
The downside of this “comparables method” is that it can be hard to find information on companies in the same stage. Data is more widely available for late-stage startups or publicly traded companies, which can skew the results.
It’s also difficult to generalize startups because each one is unique. Just because two startups have the same size team and are selling in the same sector doesn’t mean their valuations are equal. At its best, it’s an educated guess.
How to Calculate a Pre Seed Funding Valuation Range
When calculating a pre-seed funding valuation range, the factors looked at will vary widely depending on which valuation method you use.
For some methods, like the Scorecard Method that we’ll get into a bit later, the factors considered are comparable startups as well as management team, marketing and sales channels, size of the opportunity, etc. Others, like the VC Method, are mostly concerned with the post-money valuation to work backward to a pre-seed valuation. And, for other methods such as the Berkus Method, both quantitative and qualitative factors are prioritized.
The short answer: There’s no one-size-fits-all method to find your pre-seed funding valuation range.
Still, having a solid understanding of which factors play into your valuation, like any financial data, buzz around your company, and leverage, can help you figure out where your startup’s value falls.
Only once your startup starts selling will you know its actual value based on financials such as your profit and loss and cash flow position. Still, there’s some qualitative data you can use to help out, such as financial models and forecasts as well as expected profit margins.
Try to calculate your projected profit and loss to illustrate the ambitious growth of your company and the hefty return investors will make. When calculating projected loss, remember to include overhead costs such as administrative expenses, research and development, marketing budget, and the cost of sales.
The more buzz around your company, the better for your valuation. Since so much of a pre-seed startup’s value lies in its potential, a competitive environment with multiple interested investing parties can drive up the value.
Popularity among the target market also makes a difference. If you’ve started beta testing and have seen great responses and results from a limited audience, it serves as proof of traction and audience buzz, which can increase your valuation.
The more people interested in investing, the more leverage you’ll have when determining your valuation. On the other side of the coin, a startup that’s seeing low demand from investors can drop the valuation or give investors more control over it.
The best way to create leverage in your valuation is by tapping into an investor’s fear of missing out on the next big thing. If you can convince them that your company is an outlier and a unicorn in the making, on the level of Apple, Amazon, or Tesla, you can hold more power in tilting your valuation upward.
The way you convey this to investors will vary, but at the pre-seed stage, your best tools are an impressive and experienced leadership team, an expansive market opportunity, a strong vision, and an impactful product.
Types of Methods Used
A pre-seed valuation is typically a pre-money valuation, the company’s value before it receives any investor funding. There’s no one right way to calculate it, so it’s to a founder’s advantage to understand various valuation methods so you can reduce your risk and find leverage to negotiate with investors.
Three of the most used pre-money valuation strategies used by angel investors like me include the Scorecard method, VC method, and Berkus method.
The Scorecard method compares the given startup to other similar startups, considering things like market, region, and stage to adjust the valuation.
Start by determining the median pre-money valuation for other pre-revenue startups in your region and sector using an online resource like AngelList. Then, compare your startup to the perception of others within your region, considering the following factors:
- Founder, board, and management team (30%)
- Size of opportunity (25%)
- Technology/producy (15%)
- Competitive environment (10%)
- Marketing/sales (10%)
- Need for additional financing (5%)
- Other (5%)
You must decide how important each factor is, giving it a weighted value up to the marked percentages above. Then, assign your company a value for each factor based on the perception of how it compares to the average company you’re comparing it to. Assign it a value of 100% if it’s average, or more or less than that if you believe your company is stronger or weaker, respectively. With your two percentages for each factor (your market percentage and the percentage you’ve assigned your company), multiply them together to get a weighted value for each individual factor of your venture.
By then adding up the percentages, you’ll be left with a figure that will illustrate the strength of your company in comparison to the median pre-money valuation you’re using. If it’s over 100%, you’re performing better than the market, and if it’s less than 100%, you’re performing slightly worse than the average competitor.
Finally, multiply the percentage by the median pre-money valuation figure and you’ll be left with a subjective yet data-driven pre-money valuation for your unique startup.
The VC method takes a different approach, working backward from a post-money valuation to find the pre-money valuation. For this method, you’ll be using equations for both pre-money and post-money valuations:
Terminal Value / Expected ROI = Post-Money Valuation
Post-Money Valuation – Investment = Pre-Money Valuation
As seen in the post-money valuation equation, the terminal value is the projected value of an asset on a specific future date, with a projection period typically around five years. To translate the future value of the money to present value, you can multiply it by two.
Start by researching the average projected sales of companies in your industry at the end of the projection period. Then, multiply by two to determine the terminal value of your startup. Investors typically target an ROI of around 10x-30x on each investment, so using an ROI of around 20x is a good middle ground.
Determine the post-money valuation by dividing the terminal value by the ROI. Then, plug that figure into your pre-money valuation equation along with the money you’re looking to raise to calculate your estimated pre-seed valuation using the VC method.
The Berkus is the last of the three top methods to calculate a pre-seed pre-money valuation. This method relies on assigning each element of risk a number and uses both qualitative and quantitative factors to calculate a valuation.
To find your startup’s valuation per the Berkus method, assign a monetary value (up to $500k) to each of the following elements and add them up to land on a pre-money valuation:
- Sound idea – a quality, exciting business idea with potential
- Prototype – a solid product that attracts customers (reduces technology risk)
- Quality management team – skilled management team (reduces execution risk)
- Strategic relationships – powerful alliances, partners, and customer base (reduces market risk)
- Product rollout or sales – signs of growth and path to profitability (reduces production risk)
Add up the numerical values assigned to each element and you’ll have your Berkus-derived pre-money valuation with a maximum value of $2.5M.
When you’re valuing a pre-seed startup, you’re often working with a startup that has no revenue and might not even have a product yet. The lack of traction and supporting data can make calculating a pre-seed valuation challenging, but by using one or more of the methods above, you can get a better idea of how much your startup is worth. Use the valuations you’ve calculated as leverage when negotiating with investors to get the funding you need, but don’t hold on too tightly to these figures. There will always be some level of uncertainty when you’re in the early stages of building your startup.
When you find the right angel investor, you’ll land on an agreeable valuation together and start building from there. If you’re still looking for that person, reach out to MacDonald Ventures.