There is a lot written on the subject of valuations and there are a lot of opinions; however, in the last number of years, a lot of data has been gathered by angel and venture organizations such as the Angel Resources Institute and the National Angel Capital Organization on investment in pre-commercialized companies.
I have been assisting companies accelerate for the last five years through Jaguar Capital, a consulting practice I founded, as an entrepreneur-in-residence at Incubes, an accelerator for Internet-based businesses, and as chairperson of the board at Maple Leaf Angels. During this period, I have developed what I believe is a creditable method to value pre-commercialized companies called “The Shamrock Method.”
The significant difference between this method and others is where credit is given for both invested capital and a run rate for incremental revenue, in addition to giving credit to broader measures of the attributes of the business.
When valuing a business I believe there are only four main categories in assessing their valuation:
1. Solving a Problem – How disruptive is the solution the company has created? Will this solution create new markets or will it substantially change the way a product or service is delivered?
2. The Product or the Service – Has the development of the product been validated by legitimate users who are prepared to pay for the product or service and is the technology enterprise tested, ready and scalable?
3. The Business Model – This is how the company is going to earn its revenue. Is the pricing policy accepted by the market and does it stand up to competition? Is the company scalable and is there a sufficient market size that the company sales and revenue can scale?
4. The Team – Most pre-commercialized companies depend on a solid team of founders that, besides a hustler, should always have solid technology design and development capability. The moment a startup has to pay for its technology development outside the founder team, a red flag is raised.
Valuation of pre-commercialized companies starts with the median of recent seed and pre-seed investments. The main two sources of data produced for angel investment in North America are the Halo Report by the Angel Resource Institute, which last quarter reported the median valuation to be $2.7 million, and the Annual Survey of Angel Investment in Canada, produced by the National Angel Capital Organization. That survey reported the median valuation in Canada to be $5.3 million in 2013.
Although valuations are subjective and subject to the opinion of those negotiating the term sheet, there are several well-documented methods used to access the valuation of pre-commercialized companies as follows:
1. Venture Capital Method – published by Angel Resources Institute
2. Scorecard Method – published by David Berkus
3. The Risk Factor Method – published by Angel Resources Institute
Through my research and experience with viewing presentations for hundreds of companies for investment over the last five years, I would like to introduce the “The Shamrock Method” for valuing pre-commercialized companies.
• The Company receives credit for 100% of all invested capital to date with the exception of any sweat equity.
• Up to $350,000 credit for the management team.
• Up to $350,000 credit for proof of concept or product validation.
• Up to $350,000 credit for disruptiveness of technology and patents.
• Up to $350,000 credit for business model, pricing etc.
• Up to $350,000 credit for the go to market strategy, traction, growth, etc.
• Up to $350,000 credit for other including advisors, governance, financials, company infrastructure, etc.
• Credit for 2 years of revenue run rate for up to 3 years
At the high end of the range, a company would receive $2.1 million in pre-money valuation if there was absolutely no revenue or invested capital. I believe this method gives entrepreneurs credit for investment from family and friends and money they invest directly through development costs, including money spent on staffing, office suppliers, rent, legal fees etc. in addition to receiving credit for revenues generated through beta sales.
One anomaly is revenue generated through service based sales or consulting, which is often the case for companies that are bootstrapping, will require that this revenue is backed out of the calculation.
