How to Value My Startup Company Without Revenue
Updated: Jun 2, 2022
How much is your pre-revenue startup worth? A brief look at startup valuation methods to help you understand how angel and venture capital investors will value your business.
You will have heard that startup valuation is an art, not a science and it’s true—especially for pre-revenue startups. There is little concrete data to apply traditional valuation principles to, and many risk factors that could change the course of your business.
Statistically, your pre-revenue startup has a 30% chance of failing in its first year, and a 60% chance of failing in the first 3 years, so it is obvious that valuations have to take into account the risk of failure as well as the opportunity to generate high investor returns if your business succeeds. Moreover, we all know that your startup’s financial projections are likely to be obsolete in a matter of months because circumstances change.
These factors and unknowns mean that valuation for startups is largely a matter of opinion, not maths; it’s about presenting the valuation argument to a potential investor in the most persuasive way to achieve the right outcome. So it’s vital to understand how investors look at valuing your startup, so that you can be best prepared for that negotiation.
Valuation methods for later-stage companies with stable revenues and cash flows focus on two principal techniques:
Discounted cash flow analysis: this technique looks at your company’s future cash flows and applies a discount rate to those cash flows which reflects the assumed riskiness of the business, and the cost of financing the company’s growth
Comparable analysis: this technique looks at the valuations achieved by other companies like yours - in a similar sector, at a similar stage - as a guide to the likely value of your company.
Neither technique is easy to apply to a startup without revenues because there are so many unknowns, but elements of both can be very useful. Don’t get too hung up on applying proven rules and methods. Research by all means - HERE is a good run-down on startup valuation theory - but it’s a much better use of your time to build your file of evidence on the strengths of your own business.
Ultimately, startup valuation results from a negotiation between you, the startup founder, and the angel or VC investor. Valuation is driven by the strength of your value creation potential, the opportunity for an attractive return on investment, and your ability to mitigate the risk factors by proving the uniqueness of your business proposition and your strengths as a team. Risk vs reward.
Defining Risk and Reward in Startup Valuation
There’s always an interesting dynamic between an ambitious entrepreneur with a cast-iron belief in their business and a battle-worn angel or VC investor who has seen it all before and will look at your financial projections with scepticism.
Capital Pilot’s Rating System creates an objective framework for analysing risk and reward in a startup’s proposition, and here is a very quick summary:
With limited hard facts to fall back on, focusing on highlighting reward indicators and risk mitigants as preparation for a valuation discussion will be a better use of time than trying to apply a disparate group of only partially useful valuation techniques to your business.
We are in a world of guidelines, rules of thumb, and plain old-fashioned negotiation. Successful outcomes depend on creating competition between investors, sales prowess, and process management.
Let’s explore the fundamental principles that drive startup valuation.
6 Key Principles of Startup Valuation
We are in a world of guidelines, rules of thumb, and plain old-fashioned negotiation. Successful outcomes depend on creating compelling value arguments, generating competition between investors, sales prowess, and process management.
But there are some fundamental principles that drive pre-revenue startup valuation, so let’s explore them.
The Golden Rule: Whoever has the gold makes the rules. It is the investor’s capital, so they make the rules. They will decide if the valuation is attractive enough for them to part with their cash.
It’s Not Dragons Den: Reasonable investors don’t try to steal your business from you. If your potential angel or venture capital investor takes the view that it’s a battle for ownership between you and them, be wary. Savvy investors want a correct valuation, not the cheapest one. That’s because it’s important that the founder and team are motivated and, if the investor takes 90% of the business and leaves the scraps to the team which is driving the company, they are less likely to see a return on their investment. HOWEVER…
A small percentage of something vs a large percentage of nothing… Startup founders can get hung up on equity percentages or on how much their business will be worth in the future. In reality, your equity isn’t worth a lot if you cannot raise the funding you need to execute your vision. Don’t sacrifice the smaller piece of the big future pie for a big piece of the currently small pie.
Think about future rounds: Be realistic about additional future capital requirements, and communicate that to potential investors. You’re likely to raise funds again in the future, so this round is part of several valuation steps. The biggest valuation today isn’t always the best solution if it means you will struggle to achieve a higher valuation in your next fundraise. Valuing your startup realistically in the first place is critical, as is being confident that you can demonstrate a clear value increase before your next fundraise.
Future value potential drives pricing today: What your startup is worth today is mainly based on the potential future value of the company when there is an exit event. As a pre-revenue startup your valuation cannot be calculated by applying a multiple to current revenues or, most likely, by valuing your current IP or other assets. Make sure that your financial projections demonstrate your value creation potential and ambition. Why be conservative if the resulting projections don’t offer attractive value potential which meets investors’ expectations?
Valuation is about balancing risk and reward for investors: Investors in growth startups seek to balance the high risk of failure with the potential for significant returns on investments that do well. They want to see evidence that their investment can yield a serious return on investment - a 10x return is a rule of thumb.
Get Into the Mind of an Angel or Venture Capital Investor
To understand how investors are likely to value your startup without revenue, we need to know how they look at the balance of risk and reward. Let’s start by making some assumptions about the performance of an investor’s portfolio:
Let’s assume a portfolio of ten investments of £100,000, totalling £1m of capital. Let’s then assume that these 10 deals all exit in 5 years, with two highly successful, three failures, and five which do OK. And let’s assume that “OK” means a return on investment of 2x. How much do the successful deals need to return to produce a decent overall return to the investor?
The five deals that do OK achieve 2x, delivering a return of £1m: The investor gets all of their original investment back.
If the two successful deals return 5x: The overall capital return is £2m or 2x, representing a 19% annual return over five years. That’s OK, but not a great return if you consider the risks of investing in startups.
If the successful deals return 10x: The overall portfolio return is £3m or 3x, representing a 32% annual return. That’s a bit more like it.
Investors need high returns because the statistics are sobering. 90% of startups fail; a third of them in their first year. Even if an investor has a portfolio of 10 startups as above to spread the risk, statistically they still have about a 30% chance of losing their entire investment.
What does this mean for valuing your startup?
Taking 10x as the target return on investment, let’s look at valuations now and in the future. If your business achieves its goals, what will it be worth in 5 years? What could you sell the business for?
Let’s say that you can demonstrate that your business in 5 years could be worth £50 million. By the way, investors will use various techniques to estimate future value, such as looking at comparable analysis and discounted cash flow analysis, as mentioned briefly above. Simplistically, they will apply a multiple to your future revenues to represent what a buyer at that time would be willing to pay for the business. Let’s say for the sake of argument you are forecasting year 5 revenues of £10 million, and a 5x multiple of those revenues is appropriate.
The valuation today which gives the investor a 10x return would be 1/10th of £50 million or £5 million.
Assuming you’re raising £1 million now, the pre-money valuation would be £4 million (£5 million “post-money” less the £1 million to be invested).
The investor’s returns are going to be diluted by any future fundraisings. Imagine you need to raise a further £5 million at a valuation of £20 million to achieve your £50 million valuation. That would reduce the investor’s share in that future value by 25%, so a 10x return becomes a 7.5x return.
Nobody can be sure about how much additional funding your business will need, but expect your investor to take a more conservative view than you, and therefore potentially reach a different valuation conclusion.
General Rules of Thumb
We’ve looked at the math, talked about risk/reward, and identified the problems around different valuation methods. Let’s tie it all together. Of course, every situation is different. Keep that in mind. Here are some rules of thumb.
Investors want to see a significant potential value increase - say 10x their investment. Make sure that your business plan and financial forecasts show that it is achievable.
Visibility of exit potential is important for some but not all investors. It is worth assuming an exit in around 5 years to ensure you can demonstrate your value creation potential.
Few pre-revenue early-stage growth companies in the UK will achieve a pre-money valuation of greater than £2 million.
Once there is evidence of consistent and growing revenue, pre-money valuations can rise to £5 million or more. Consistent revenue will validate your business model and reduce investor risk, so valuations increase.
If you are raising an appropriate amount of funding relative to your stage of development as a business, you should expect to sell between 15% and 25% of your business. This tends to hold true through the seed stage and towards Series A.
Putting It All Together: Startup Valuation
Valuing your startup is much more a matter of negotiation with your investor than a mathematical exercise. A successful outcome depends upon highlighting your value drivers and risk mitigants. If you research and build a sensible valuation argument based on industry-accepted rules of thumb, all should be well, and valuation will not be a sticking point.
Remember the bigger picture. Your funding round gives you the resources to build value for you and your investors; without it, you may not have that opportunity. Stick within industry boundaries, and expect the same from your angel or VC.
Where Can I Learn More?
Capital Pilot’s mission is to deliver equal access to funding for everyone. Everywhere. Get a rating to understand how investable your business is, along with key insights into how you can make your business more attractive to potential investors. For more information, check out all our Startup FAQs here. Or, if you are ready to get your investability assessment and rating, click here.