For those of us who’ve invested in early stage companies, especially technology start-ups, we have confronted a universal problem. There are many ways to project the value of a company for purposes of pricing an investment, but all rely upon the revenue and profit projections of the entrepreneur as a starting point. Many formulas then discount those projections according to some set percentage or by assigning weight to elements of the enterprise.
And in my opinion, all fail to take into account the universal truth – that fewer than one in a thousand start-ups meet or exceed their projected revenues in the periods planned.
Years ago, confronted with the same conundrum, in the middle 1990’s I came up with a method of assessing the value of critical elements of a start-up without having to analyze the projected financials, except to the extent that the investor believes in the potential of a company to reach over $20 million in revenues by the fifth year of business.
First published widely in the book, “Winning Angels” by Harvard’s Amis and Stevenson with my permission in 2001, the method has undergone a number of refinements over the years, particularly in the maximum assigned to each element of enterprise value, reducing those amounts as the investment market adjusted from the craziness of the bubble to more logical values in the years that followed. Because the Internet has such a long memory and documents from the distant past can be found with ease, a search the “The Berkus Method” today will yield a number of conflicting valuations culled from the many subsequent publications of the method over the ensuing years.
[Email readers continue here…] Here is the latest fine-tuning of the method. You should be able to adopt it to most any kind of business enterprise if your aim is to establish an early, most often pre-revenue valuation to a start-up that has potential of reaching over $20 million in revenues within five years:
| If Exists: | Add to Company Value up to: |
| Sound Idea (basic value) | $1/2 million |
| Prototype (reducing technology risk) | $1/2 million |
| Quality Management Team (reducing execution risk) | $1/2 million |
| Strategic relationships (reducing market risk) | $1/2 million |
| Product Rollout or Sales (reducing production risk) | $1/2 million |
Note that these numbers are maximums that can be “earned” to form a valuation, allowing for a pre-revenue valuation of up to $2 million (or a post rollout value of up to $2.5 million), but certainly also allowing the investor to put much lower values into each test, resulting in valuations well below that amount.
There is no question that start-up valuations must be kept at a low enough amount to allow for the extreme risk taken by the investor and to provide some opportunity for the investment to achieve a ten times increase in value over its life.
Once a company is in revenues for any period of time, this method is no longer applicable, as most everyone will use actual revenues to project value over time.
The numbers are outdated and someone should revise it
See post “After 20 years, updating the Berkus Method” here: https://berkonomics.com/?p=2752
-Dave
Hi Dave,
I am from Bhutan and as one of the least developed country, the max valuation of $500K of each metrics is not applicable and too high for us. It would be grateful if you could explain how you came up with the max valuation of each metric so that it can be made relevant in our economy.
Thankyou.
The maximum should have been flexible by geography and discipline. See my subsequent update to the Method in 2016 by clicking here: https://berkonomics.com/?p=2752
Good luck!
Dave
Thanks Dave,
The point here is since the major part of the investment will be used in acquiring content rather than just cash burning, how the pre-money valuation could be arrived assuming there is no major prior content bank. Further, the data of subscriber will add great value to the company. Pls advise.
Dear Dave,
We are starting a OTT platform which will have a large content bank. In this case how the pre-money valuation could be arrived given the fact that the content has its own value apart from the five factors that you have mentioned. The majority of the investment will go into acquiring the content.
Vishal,
You bring up one of the issues we should discuss. Let’s say that your startup already has $1MMM in the bank. Should you add $1MM to the valuation? Most all investors say “no” since it is assumed that the cash will be used in the business to grow it. Therefore a $2MM valuation with $1MM in cash would not yield a $3MM valuation. Yes, I know this seems counter-intuitive. It is the same for your content, which may create a barrier to entry and increase valuation that way, but not just by the value of the content. Entrepreneurs will always object; investors will most always ignore assets already in hand.
-Dave
Dear Dave
Greetings from Switzerland.
I am looking at pre-earning start up active in the software vendor business for so-called “independent wealth managers” (roughly 2500 companies) in Switzerland. These guys will be heavily regulated soon (law into force in 2022) and need urgently a cost-efficient solution in compliance matters.
The company (4 Seniors, very professional guys in sales and IT, compliance) has almost finished its unique digital compliance toolbox (E(Margin)=30%) and also already has several early mover clients. 2 strategic partners representing around 1500 client accesses are close to be signed. Expected revenues in 3 yrs of $ 9 Mio with a growth rate of 20% p.a.
Any hint/idea what kind of pre-money valuation would make sense?
Tks Stefan
Stephan,
Thanks for your comment. I do not make it a habit of providing valuations in this environment. But I do hope you’ll use the information I’ve provided to guide yourself. All the best,
Dave
Dear Dave
What if the company is not expected to reach USD 20 million in 5 years, lets say, 10 million instead?
Thanks
Bilal
Syed,
The $20MM target assures the investor that there could be a large market and gives the company five years to “figure it out” and begin to penetrate. A lower number does reduce the valuation a bit but not in proportion. And there are industries such as pharma where those numbers make no sense in calculating valuation. And how about software with near 100% gross margins where a lesser number with low overhead flows toward the bottom line…
Dave
Dear Barkus,
Thank you for your contribution to facilitate the valuation for investors. However, I think Berkus method is not providing enough metrics to better value each one of the 5 elements. for example, for the management, it mush provide sub-elements that make the valuation less subjective, I just received an answer from our potential investor who explained they followed Berkus method and they valuated our company at 0.9m pre money valuation. and when I requested further clarification, he mentioned one example where they valuated our team to 0.2/0.5, and I guess this is was not even close to how experienced our team. I am now preparing our response for all of these points to support better valuation. For the management, I would divide the item into sub parameters and give grade/value/weight for each one. and here is my suggestion based on our team
Team management total 0.5m
1) Year of experience for the team = in our case its 51 experience for the tema.
2) Academic degree= founders have 2 master degree in MBA from Kellogg, and 1 PhD in Social media marketing from Lund university in Sweden.
3) Entrepreneurship knowledge = all founders at least established one company and 2 of the founders exist from previous successful companies which valued at over 20m
4) Commitment: 3 founders are working full time in the startup, another 4 employees working as full time, and 3 part-time
5) Complimentary experience: founders experience in Marketing, business and Engineering
I believe providing more tools for each parameters in your model will minimize the valuation error rate, usually, investors push to devalue the company and in order to have a more reasonable valuation, I suggest you provide more attributes and explain each one in more than a number.
Mohammed,
First, your investors may have been harsh in their appraisal of value. You concentrate on management and ask that we expand the measures. I believe that would defeat the simplicity we have made a hallmark of this method. But there are factors that might have changed their valuation considerably: geographic location (Silicon Valley values are much higher than Oklahoma City), type of business (medical device and pharma startups are more highly valued as they progress with certifications (even if no revenues), and often tech businesses are more highly valued than, say, restaurants. In your response, think of alternatives to the strict value metrics they may have used.
Dave
Hello Dave,
How did you determine the $2 million magic number that the 4 elements are based on?
Thanks,
Corey
Corey,
Here is a link to the revised Berkus Method (after 20 years) explaining how that $500K number can move (usually up) depending upon geographic location and industry.
-Dave
Hello sir Dave,
Im planning to invest on a losing company, which has an existing value of 2M usdollars, I believe the company is about to get a braekthrough as i saw its potential specifically since it has a unique product, the company valuation analysis in 5 years would be 40M USD, am going to invest 200k usd however upon copmputation of the company i would only get a share of 0.006 is this accepatable….
Kiangkaing,
NEVER use the company’s estimate of value in future years! You invest $200K with a $2MM prmoney valuation now and receive 200/2200 or 9% of the company. I would also explore with your attorney establishing a preferred class of shares for this investment. Your example is NEVER acceptable. Walk from the investment if a seller of shares suggests using future value as an indicator of present value.
-Dave
Hello Mr. Berkus,
Thank you so much for coming up with this pre-money valuation. It is a great reference! I have a couple of follow-up questions if you don’t mind:
1/ Is the method only applicable to the US and developed countries?
2/ My startup is for emerging markets, specifically SE Asia. Should I rely on any indices, or should I refer to comparable companies in the local market? Can you help elaborate on that?
Thank you!
Lee,
The method is applicable in all countries. Just change the currency and the minimum amounts per element to fit your economy and investor profile. If you csan find the average investment by angel investors in companies close to your stage and type, let that be the starting point for four times the element’s total valuation in local currency and terms.
Dave
Maybe I am looking at this wrong, but in your response to Emanno wouldn’t a $100k investment that leads to an 18.5% share of equity equate to a $540,540 valuation? If you divide $600k into $100k, you get 16.67%
Mark,
I re-read my response and you are right. The calculation would yield a 16.67% ownership. Nice catch.
Dave
If the company is pre-revenue, what method(s) should be used to value the common stock for 409a purposes? (thanks for your response.)
A 409a protects the company when issuing stock options to employees. Some pre-revenue companies that have raised many millions will want to have that protection and order a 409a. (Carta is cheaper at this than most any private appraiser.) Smaller pre-revenue companies have much less a risk and use of this method with documentation for the board is not a risk. The SEC is the primary interested party and only playing with backdating of options combined with a whistleblower’s call would cause risk to a small company described here. Good question. Very, very low risk if documented.
-Dave
Has the Berkus Method stood up to an IRS 409a review?
The 409a appraisal is appropriate for companies into revenues. The Berkus Method is meant to cover those pre-revenue.
-Dave
Dear Dave,
Thanks for your kind permission of using the method.
All the best!
-Brandon
Very glad to see your article about this brilliant method of valuating early stage star-ups. I am doing early stage investor training (training “rich” people to be Angel investors) I myself also investing in early stage companies. Is it fine with you if I use your method in my talks?
Are you in Dallas? My family just moved to Dallas and I will visit Dallas frequently. Would be great if have chance to meet you and learn more from you in the future. Angel investment is boosting in China now and are you considering doing something there? We could collaborate :).
Brandon,
You are welcome to use the method with attribution. I am in Los Angeles. All the best with your teaching!
-Dave
please could you advise examples (with calculation) where Berkus method was used at startup time for a well known company today?
Mukesh,
I am not the one to use the method and assign the values to those that use the method, so I don’t have the information you seek. Sorry I can’r help.
-Dave
Mr, Berkus,
I recently reviewed a prospectus applying the Berkus Valuation Method, valuing four elements at $0.5 mm and Product for $1 mm, a total value of $3 mm. Based on your article, it seems viable to use a maximum of $5 mm ($1 mm per element) when projected revenues in year 1 & 2 approximate $55 mm and $65 mm.
Your thoughts?
Robert,
Use of the Method for an early stage startup is its intent. And you’ll note in my 2016 update that the $500K elements can and should be adjusted (usually upward) to take into account the geographical base of the startup. Silicon Valley startups would usually command fouble that per element. But using the Method to attempt to find valuations in the future based upon projected revenue was not in the original design nor is it today. Too many plans fail to reach even a tiny portion of their projected revenues during those first critical years that I discourage its use for projecting value in future years. Period. Hope this helps.
– Dave
It is awesome and easy to use. I’d like to learn more of it
Roz,
It would be difficult to help with this small amount of information. As yourself how fast the company is growing – the faster the more valuable. Will your team get you to profitability? Is the competition holding your prices down so much that profit is difficult to obtain? What are comparable companies in Africa worth? Certainly less than Silicon Valley…
Good luck with you enterprise!
Dave
I have an issue
New startup pre-revenue
Food delivery on line
2 sided on demand platform
I am working on it since 2 years and we will go online in few weeks
some investors are interested
How can i valuate the company?
should i give part of my 100% or producing new %?
Your suggestion is so precious
thanks
Emanno,
Thanks for your information. In short, early angel investors should receive a bargain, but not so much as to overwhelm your ownership percentage. Work it backwards. If you need $100,000, and not more within a year or less, it would be fair to give the investors a bargain $500,000 pemoney valuation, for 18.5% of the company. Note how I did this. You issue new stock, not give part of your original shares. The “premoney” value is your current value. Add their investment amount and that is the “postmoney” value. Divide that into the investor total investment and that will determine the postmoney percentage of ownership. Good luck!
Dave
How do you calculate the value for each element?
Fazail,
Valuation of each element is subjective. If you believe that management is capable of taking the company to profitability without adding a CEO or major change, that might give that element full value. If you see a risk in that, or need for professional management to be added to that milestone, reduce the value of that element.
Hope this helps.
Dave
this is very Helpful to me right now. Currently trying to value our new startup project at MAXIBU.
Thanks DAVE.
HI ,
I am currently applying DAVE BERKUS method for a mature startup in the medical space struggling with a PE investor for valuations .
I’ll update once the deal whether it goes through or not … Thanks and Good to know the BERKUS Method
I found this very useful and easy to understand, thanks.
For early stage companies, I use the “ Berkus Method ” approach. Valuing an early stage company is not a precise exercise, even if the above methods lead you to believe that there is some precision in doing so.
Nice one
This is an excellent methodology, thank you.
I wonder if you have revised the numbers in the six years since first publishing it? Are the factors still all max $500k steps, or have they increased?
Many thanks for your further thoughts
David.
Dave,
I was working with one of my new companies on a pre-screen with investors today. Someone recommended that we look at the Berkus Method of valuation. I said…… wait a minute. Is that DAVE Berkus. They said they did not know but it had something to do with Harvard. I quickly Googled it and WaLa, my old friend came up.
How are you? Do you ever get to Dallas? Regardless, good wishes my old friend. Dennis