Startup resources - Valuation
Valuation of startups & early stage companies, specially pre revenue, is more an art than science. No wonder convertible notes (a debt instrument deferring valuation to the next financing event) became so incresingly popular. See more on the topic here.
Nevertheless, in our experience, the Risk Factor Summation Method, also known as RFS method, an more sophisticaded version of the all mighty Berkus method, and originally developed by Ohio TechAngels, is one of the best approaches to engage investors in understanding key aspects of the risk profile in a new venture. A healthy approach for a long term partnership.
The Risk Factor Summation Method
This method is ”Reflecting the premise that the higher the number of risk factors, then the higher the overall risk, this method forces investors to think about the various types of risks which a particular venture must manage in order to achieve a lucrative exit. Of course, the largest is always ‘Management Risk’ which demands the most consideration and investors feel is the most overarching risk in any venture. While this method certainly considers the level of management risk it also prompts the user to assess other risk types.”
The Risk Factor Summation Method is mostly used for pre money valuation and for pre revenue companies. This Startup Valuation method can be broken down into two stages:
Stage 1: Determining the initial value
This is done by researching the market for similar companies or competitors in the same field. Analizing their financing rounds and as much as possible of their market development. In VC terminology this is the process of looking for 'market comparables'.
Stage 2: Analyzing the specific Risks
This is a preliminary lists of risk factors to be considered, in qualitative priority:
- Management risks
- Stage of the business
- Legislation/political risk
- Go to market risk
- Funding/capital raising risk
- Manufacturing/Service delivery risk
- Competition risk
- Technology risk
- Litigation risk
- International risk
- Reputation risk
- Potential lucrative exit
The analysis needs to rate these risk facts according to the following scale:
- excellent : add $500,000
- good : add $250,000
- neutral : no change
- poor : subtract $250,000
- excessively poor : subtract $500,000
Via this method, the investors can thus get a fair valuation based on risks adjusted criteria.
If you want to see this in action and get your company evaluated for the cost of an Uber ride head on to: