The Berkus Method – Valuing the Early Stage Investment.

             For those of us who’ve invested in early stage companies, especially technology start-ups, we have confronted a universal problem.  There are many ways to project the value of a company for purposes of pricing an investment, but all rely upon the revenue and profit projections of the entrepreneur as a starting point.  Many formulas then discount those projections according to some set percentage or by assigning weight to elements of the enterprise.

             And in my opinion, all fail to take into account the universal truth – that fewer than one in a thousand start-ups meet or exceed their projected revenues in the periods planned.

            Years ago, confronted with the same conundrum, in the middle 1990’s I came up with a method of assessing the value of critical elements of a start-up without having to analyze the projected financials, except to the extent that the investor believes in the potential of a company to reach over $20 million in revenues by the fifth year of business.

            First published widely in the book, “Winning Angels” by Harvard’s Amis and Stevenson with my permission in 2001, the method has undergone a number of refinements over the years, particularly in the maximum assigned to each element of enterprise value, reducing those amounts as the investment market adjusted from the craziness of the bubble to more logical values in the years that followed.  Because the Internet has such a long memory and documents from the distant past can be found with ease, a search the “The Berkus Method” today will yield a number of conflicting valuations culled from the many subsequent publications of the method over the ensuing years.

[Email readers continue here…]  Here is the latest fine-tuning of the method. You should be able to adopt it to most any kind of business enterprise if your aim is to establish an early, most often pre-revenue valuation to a start-up that has potential of reaching over $20 million in revenues within five years:

If Exists: Add to Company Value up to:
Sound Idea (basic value) $1/2 million
Prototype (reducing  technology risk) $1/2 million
Quality Management Team (reducing execution risk) $1/2 million
Strategic relationships (reducing market risk) $1/2 million
Product Rollout or Sales (reducing production risk) $1/2 million
 

                Note that these numbers are maximums that can be “earned” to form a valuation, allowing for a pre-revenue valuation of up to $2 million (or a post rollout value of up to $2.5 million), but certainly also allowing the investor to put much lower values into each test, resulting in valuations well below that amount.

                There is no question that start-up valuations must be kept at a low enough amount to allow for the extreme risk taken by the investor and to provide some opportunity for the investment to achieve a ten times increase in value over its life.

                Once a company is in revenues for any period of time, this method is no longer applicable, as most everyone will use actual revenues to project value over time.

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6 Responses to The Berkus Method – Valuing the Early Stage Investment.

  1. Dennis Cagan says:

    Dave,
    I was working with one of my new companies on a pre-screen with investors today. Someone recommended that we look at the Berkus Method of valuation. I said…… wait a minute. Is that DAVE Berkus. They said they did not know but it had something to do with Harvard. I quickly Googled it and WaLa, my old friend came up.
    How are you? Do you ever get to Dallas? Regardless, good wishes my old friend. Dennis

  2. Pingback: How to Value an Early-Stage Start-Up Company | Something's Brewing

  3. David Roberts says:

    This is an excellent methodology, thank you.

    I wonder if you have revised the numbers in the six years since first publishing it? Are the factors still all max $500k steps, or have they increased?

    Many thanks for your further thoughts

    David.

  4. find-way.net says:

    For early stage companies, I use the “ Berkus Method ” approach. Valuing an early stage company is not a precise exercise, even if the above methods lead you to believe that there is some precision in doing so.

  5. I found this very useful and easy to understand, thanks.

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