If you are starting a business or have never accepted outside investment from angel investors or venture capitalists, it might be a good idea to figure out your company’s pre-money valuation. Pre-money valuation is the value attributed to a company before it receives any public funding or outside investment. The number is important because it may help determine how much investment is generated during a capital raising round.
Figuring out a pre-money valuation for most companies is quite a difficult task. Often times, entrepreneurs attempt to put financial projections together and then perform discounted cash flow analyses (DCF) to determine a pre-money value. This is usually time not well spent because many projections are needed to perform a DCF. Often times, an entrepreneur’s financial projections for a brand new company are very inaccurate. Thus, the DCF is usually way off from a true value and unreliable.
Angel investors, however, are extremely good at what they do and have devised many ways to determine pre-money valuation, although none of the methods are perfect. Because of this, even angel investors typically recommend using a few valuation methods and taking an average. Links to many pre-money valuation methods can be found on famous angel investor Bill Payne’s website.
One of those methods, the Dave Berkus method, is simple to implement and makes for a great starting point. For each of the following five characteristics your startup business has, add between $0 and $500,000: a quality management team, a sound idea, a working prototype, a quality board of directors, a product rollout or sales. With this method, a viable pre-money valuation for a new business is between $0 and $2.5 million.
Pre-money valuation is a great number to calculate and know going forward. If you, as a small business owner, decide to raise investor funds, you have a great idea of the true value of your business going into negotiations.