There are several different ways for investors can place a value on a venture so they can systematically determine for themselves how much equity their investment should purchase.
THE THREE MOST POPULAR WAYS ARE:
• The Harvard Method
• The Berkus Method
• The Scorecard Method
The Harvard Method
The Harvard Method, also called “The Venture Capital Method”, depends on projections of future earnings.
First, you estimate / project the Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) 3-5 years out.
Next determine an appropriate valuation multiple based on the industry and the size of the company which gives a projected acquisition value, EBITDA X Valuation Multiple = Acquisition Price. Finally discount to the current point in time, yielding a current value for the company.
There is a lot of room for adjusting the numbers, because the ‘method’ depends on:
• The EBITDA projection
• The Valuation Multiple
• The Discount Factor
For example:
• Earnings are projected to be $100,000 in 3 years
• Valuation Multiple is 5
• Company will be worth $500,000
• A 50% ownership will be worth $250,000
• For a 500% (5x) return, invest $50,000 today for 50% of the company
• For a 1000% (10x) return, invest $25,000 today for 50% of the company
Most angel investors want a chance at a greater return than 5x, because they realize that many of their investments will not pay off at all. They want – and need – a chance at a home run to be successful in the long run.
The Berkus Method
The Berkus Method is name for Dave Berkus, a prominent angel investor from southern California. The method was first published in 2001 and has a lot of variations. But generally, the value of a company today is calculated based on the progress the company has made. The method assigns a current maximum value of $500,000 for each of the following:
• Sound Idea
• Prototype
• Quality Management Team
• Strategic Relationships
• Product Rollout or Sales
The angel investor gets to decide how much to value to attribute to each of the elements with maximum value being $2.5 million. It is similar to putting value on a piece of real property based on the cost to replace it in both time and money.
The Scorecard Method
The Scorecard Method is very popular, because every angel investor or angel group gets to develop their own scorecard. Generally, a company is rated in several categories and the total score is used to project a value relative to other companies of similar size in the same industry.
Here’s an actual scorecard evaluation completed by the Angel Investors Network a few months ago for one of our clients. They hired us to analyze their offering in order to close some of their gaps and be better prepared for conversations with prospective investors.
As you can see, the big red flag was in their progress- they had done very little market testing. They had created a prototype, but it wasn’t in the hands of customers yet and they had no sales or sales pipeline.
Summary
These are just three of the methods that you can use, and investors will use, to determine the value of your company today. It is recommended that you use multiple methods and be prepared to back up your valuation claim with an intelligent conversation on all of the methods.
