Valuation: An investor’s perennial dilemma - Part 3
The Berkus Method
Hello, and welcome back to the Step by Step newsletter!
Thank you for opening this week’s edition of the newsletter. Last week we talked about The Venture Capital (VC) Method, a popular pre-money valuation method used by angel investors.
This newsletter is part three of three posts about valuing a start-up. This time we are talking about The Dave Berkus Method.
Who is Dave Berkus?
Dave Berkus is a super angel and a legend in the world of angel investing. He is one of the most prolific angel investors, with over 200 early-stage technology investments. After a series of start-ups that failed to meet their financial projection, he realized he couldn’t rely on their data, which is when he came up with the Dave Berkus Method, which has been used by over 1,000,000 entrepreneurs and early-stage investors, and is recognized as an industry standard with more than 300,000 references to it in search engines worldwide.
Dave Berkus Method
It can be challenging to value a start-up and have meaningful/ reliable projections; most companies never even hit their targets, which is why Dave Berkus, a legendary angel investor, came up with the Dave Berkus method.
Angel Investors take on so much risk when investing in early-stage startups and young entrepreneurs, hence valuing start-ups is a big deal. This method helps reduce the risk as much as possible.
How does the method work?
Rather than using a traditional DCF method, Berkus appoints a dollar value to each risk-incusing factor the start-up has.
These factors include:
Sound Idea (basic value)
Prototype (reduces technology risk)
Quality Management Team (reduces execution risk)
Strategic Relationships (reduces market risk)
Product Rollout or Sales (reduces production risk)
The method doesn't stop at these qualitative drivers - the next step is to assign a quantitative value to each of the factors. Berkus set a maximum value of $500K for each factor. Hence the maximum pre-money valuation can be $2.5 million.
To get a 10X return in its lifetime, you should be able to envision it breaking $20 million in 5 years.
Let’s try it out
Here is a made-up assessment of a made-up start-up to illustrate the principles of the method -
Keeping $500k as the maximum for each factor, I assigned the highest value to the team due to the founder’s experience and diligent team. The prototype also received a good score because it’s low risk. The company was given a pre-money valuation of $1.15 million.
Keeping it flexible
In 2016, Berkus updated the method and said the norms of the method were too restrictive. So you should be able to change the relevant factors to the specific industry and modify the maximum value to assign depending on the region or the domain.
For example, the pre-money valuations of an IT company based in Banglore will be highly competitive compared to a similar start-up in Ahemdabad.
Keeping this in mind, you should modify the overall method to suit the start-up you value.
Before you leave
It is recommended to use multiple methods to come to an accurate valuation, and experience is excellent for anticipating values and returns.
Check out -
Part 1 - Scorecard Valuation Method
Part 2 - The Venture Capital (VC) Method
Keep in touch for more valuable insights and curated resources.
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