Startups are always looking to raise capital because of the issues they face in the initial stages of the business. And one major way to do so is through investors. Investors put money in startups to generate returns in the future. But how do startups decide how much of the business they are willing to let go? What about investors? How do they decide how much money to put in a startup? What are the factors that affect the decision, and where can these amounts be found?
In this article, we will tell you about the scorecard valuation, how it helps investors, how it works, and how to calculate a company’s value.
Scorecard Valuation Method
In simple terms, the scorecard company valuation helps angel investors find an average valuation for startups that are able to grow, but with no revenue yet. This method uses weighted percentages and market data to determine an acceptable average.
What is the scorecard valuation method?
Also known as the Bill Payne valuation method, the scorecard valuation method is a widely preferred method by angel investors. In this method, the target startup seeking investment is compared with other similar funded startups. The scorecard valuation model compares these companies on the basis of several factors like stage, market, and region. These factors have a direct impact on the valuation of the company. Factors as such also affect the average valuation of the company.
The scorecard method is used to compare the target company to other similar companies in the industry. The basis on which they compare the companies are the stage of development, business sector, and geographic location. Before adjusting the median of the appraisal, the target company will be compared with others by the investor for several factors. This will value the company level and help them decide the amount they would invest in the company.
How scorecard valuation helps angel investors and early-stage companies?
Scorecards are usually used in sports so that the fans, players, and the coach can break down and understand the factors that led to them winning or losing. This is important as this information will help them determine the strengths and weaknesses of the team. Similarly in the business world, scorecards are mostly used the same way as they are a handy tool for investors. The scorecard valuation model helps determine the average value of the target company.
When a startup approaches angel investors for financing, investors use this method as a way to determine the value of a startup. Factors that make the startup more or less valuable are highlighted in these scorecards. The main factors that affect the investor’s decision are the quality of the management team, market size, and the industry sector.
It is essential to know why entrepreneurs and investors find company valuation so essential. There are two main types of valuation, before the investment, or “pre-money” and after the investment, or “post-money”.
There are times the company does a valuation to determine how much they are willing to let go in order to raise capital. On the other hand, angel investors use the company valuation method regularly. The reason for this is that their calculation plays a huge role in the success of the investment. When they are comfortable with the pre-money scorecard valuation model, they will invest in a company.
How does a Scorecard valuation work?
Valuing a startup is quite interesting, as a majority of startups do not have revenue. Inherently, investors valuing established companies are vastly dissimilar to the valuation of startups. Established companies not only have operating expenses, but also generate income and incur losses at times.
Investors always tend to put a higher value on the management team and the entrepreneur of the company. They do so because financial projections and quantitative analysis do not always predict the future of a company in its initial stages.
For the valuation of pre-money, there is more than one way to derive the amount for a startup. This is why it is essential to gather information and in-depth knowledge about the valuation methodologies. The best way to do so is by contacting other angel investors and entrepreneurs. Pre-money valuation is the value of the startup before it gets any investment from outside sources.
Determine the average pre-money valuation for pre-revenue startups
Determining the median of the pre-money valuation using the scorecard valuation method is the first step of this process. We use the pre-revenue company’s pre-money valuation in the same business sector and region of the target company to derive the median. The pre-money valuation of companies in the US are different depending on the geographic location, as the region also affects the competitive environment of the startup venture.
We use the same region as in the majority of them; the pre-money valuation is only slightly different from one business sector to another. If local data available is insufficient, the investor can read the Angel Capital Association’s most recent national study in the “Angel Funders Report”.
Let us take an example: In ABC Ltd., the seed stage deal is $8 million, and the pre-seed deal is $6 million. In this case, the pertinent median for the local pre-money valuation is $7 million. This is so because we assume the median to be the midpoint between the pre-seed and the seed stage deals. Additionally, the strengths and weaknesses of the target company are considered, and the starting point is further adjusted in the scorecard valuation method.
To determine the pre-money valuation of pre-revenue businesses, the next step involves comparing the target company using the scorecard valuation method to the deals done that are the same in your region.
The scorecard method is the most popular way to derive a pre-money value. The main criteria for the scorecard method in order are:
- Board, entrepreneur, the management team – 25%
- Size of opportunity – 20%
- Technology/Product – 18%
- Marketing/Sales – 15%
- Need for additional financing – 10%
- Others – 10%
These percentages can be adjusted according to the investor’s preferences, but the important part is the potential of the startup. The above criteria are ranked in a subjective manner, for startup ventures, this is the typical order for an investor appraisal. One point that often catches many off-guard is that investors rank the technology and product below the size of the opportunity, and both of them are below the management team.
While building a business, the quality of the management team complements the success of the product and the company. A great management team will work on fixing all early flaws in the product. Scalability is essential as it is directly related to the returns of the investor. In a company, having intellectual property and a good product is essential, but more important is the quality and skills of the management team as it is key to the success of the product.
Calculate the valuation
Calculating the valuation of a company is not a complicated task. To understand it better, let’s take an example.
Using the same example as above, ABC Ltd. is looking for angel investors to raise capital for the company. The interested investor drafts a scorecard company valuation for the target company.
Let us assume that ABC Ltd. has:
- Large market opportunity (100%)
- A strong team (130% of norm)
- An average technology and product (100%)
When we take a look at ABC Ltd’s strength of market competition, it is weaker compared to others at 80%. The early feedback from customers for the offering product is excellent. Therefore:
- Other (100%)
On the other hand, management was facing problems with their sales channels. They need to work on establishing better sales channels and also build their partnerships (80%). All these data will be compiled and put into a table, giving a short summary of the company.
Using the data of ABC Ltd., we can derive the pre-money valuation of the company:
|Comparison facts||Target Company||Range||Factor|
|Size of Opportunity||140%||20%||0.28|
|Strength of Team & Entrepreneur||130%||25%||0.325|
|Product & Technology||100%||20%||0.2|
|Need For Additional Investment||100%||6%||0.06|
Using the previous example: if we multiply the median of the pre-money valuation by the sum of factors, we get the target company’s pre-valuation.
= 1.1205 x $7,000,000
The pre-money valuation of the target company ABC Ltd. is $7.843 million. This valuation is not only used as the current value of the business before revenue and investment, but it is also used to calculate the value of the company’s shares.
How to use the Scorecard Valuation Method for your startup?
It is essential to have a good understanding of the scorecard valuation method. This method provides data that assists angels in adjusting the median valuation of targeted startups in a similar business sector. It offers factors and issues to consider while judging the company’s value. And with outside investment, a startup should also have a good understanding of their share ownership and cap table.
Eqvista is a sophisticated online cap table management system that allows founders to easily track their company shares. Our software also has advanced financial modeling tools, like waterfall analysis and round modeling, to help founders and investors in case of a buyout or share dilution. Check out our resource page or contact us today!