Valuation: An investor’s perennial dilemma
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This newsletter is a deep dive into a valuation method called the Scorecard Valuation Method. This is the first of a series of three where we discuss valuation methods to help budding angel investors.
India is at an inflection point today. You can see new startups coming up at an unprecedented rate.
If you have been investing in startups, valuing early-stage startups without existing revenue is always an interesting discussion.
Fundamentally, valuing an established company and a startup are very different ball games. Any mathematical/statistical analysis and projections cannot predict the future success of an early startup. This is why investors put a lot of value on the entrepreneur and management team.
Trying to value a startup in one way to determine the pre-money valuation (the startup’s value before receiving outside investment) would not be the best approach. So let’s dive deep into understanding valuation methodologies from other entrepreneurs and angel investors.
In a series of posts, We will try to understand three pre-money valuation methods used by angel investors. We will be starting our journey with the Scorecard Valuation Method.
Scorecard Valuation Method
Also known as the Bill Payne valuation method, it is one of the most popular methods. Here a comparison of the startup (raising angel investment) is made to other funded startups while adjusting for factors such as region, market, and stage.
It starts with determining the average pre-money valuation for shortlisted pre-revenue startups. Various investor groups consider pre-money valuations across regions as a good baseline.
AngelList is an excellent resource for exploring startup valuation data from thousands of startups. You can browse evaluation parameters like market, location, quarter, and founder background.
Then its time to compare the startup to other startups within the same region using different factors like:
Management Team strength (0–30%)
Size of Opportunity (0–25%)
Competitive Environment (0–10%)
Marketing/Sales Channels (0–10%)
These rankings and weightage are subjective and can vary based on your preference, but the main factor besides scalability is the team.
“In building a business, the quality of the team is paramount to success. A great team will fix early product flaws, but the reverse is not true.”
The final step is to calculate the percentage weights. For example, in his analysis, Payne explained this - The team is strong (125% comparison) with a vast market opportunity (150% comparison). However, the startup plays in a highly competitive environment (75%). By multiplying the weighted average factor with the average pre-money valuation (arrived in the first step), the pre-money valuation of the target startup arrives.
The best part of this approach is the particular focus on the team.
The Method is undoubtedly subjective, but given the risk undertaken by you, this approach makes sense for investing in early-stage startups.
We will be going through other valuation methods in our future series.
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