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What is the Berkus Startup Valuation Method?

What is it?

The Berkus method is a pre-revenue valuation approach based solely on qualitative methods, much like the Scorecard Valuation Method discussed before.

Few startups manage to meet their financial projections, especially in the very early stages, so valuation approaches like the Berkus method are a sound way to provide a valuation when the economic metrics are still not solid, or enough, to grant an accurate valuation.

How does it work?

This methodology aims to provide a valuation based on five critical success dimensions:

  • πŸ› Basic value
  • πŸ¦‹ Technology
  • 🦐 Execution
  • 🦞 Strategic relationships in its core market
  • 🐑 Production and consequent sales

The Berkus valuation method allocates value to the business idea and the four principal success factors of the company. Each one of these dimensions constitutes a risk factor in the success of the startup as represented by the matrix below:

Startup Risk Matrix

It studies these crucial areas in a startup and assigns each one of them a value ranging between $0-$500.000. Thus, the maximum theoretical pre-money valuation this approach allows is $2.5M.

It is clear this approach relies heavily on geographical location and leans toward the US to establish the baseline, as in Europe it varies depending on the country.

Criteria to analyze each dimension separately

πŸ› Basic value (or strength of the idea)

The adage says "Ideas are worth nothing, what it's important is execution". That has a high degree of truth, I'm sure most of us can relate to discovering a new business pop up in our hometown or seeing a new startup getting funded and thinking "I thought about this idea years ago!". Someone else just made it happen.

The principle still holds though. To evaluate the soundness of the idea we must keep an eye on a bunch of factors that contribute to its success:

  • πŸ‚πŸ» Proprietary nature of the idea – When we consider the idea of a product or service, it needs to be secure through patents and copyrights. It also needs to have the potential to make significant returns.

  • πŸŒπŸ»β€β™€οΈ Planned growth and growth in a well-defined direction carry high potential, making their incorporation in the startup highly beneficial.

  • πŸ§—πŸ» The scalability of an idea – a business with scalable revenue potential – is an important driver of the emergence and survival of ventures. For a startup to succeed in market competition, it must possess a scalable idea.

  • πŸ‹πŸ»β€β™‚οΈ The attractiveness of a startup idea to a wide range of audiences depends largely on the prevailing socio-political environment. So the presumption of ​​conformity is needed.

  • πŸ€ΈπŸ»β€β™‚οΈ Idea Validation - To reduce risk in the implementation phase, ideas must undergo extensive testing with a wide range of audiences.

πŸ¦‹ Technology (Prototype)

This dimension aims to reduce the technological risk of the startup venture. What is the level of quality of the startup's prototype when confronted with the numerous technological risks a new project may face: cyber attacks, GDPR compliance (in Europe), tech stack difficulty of replication, etc?

🦐 Execution

One must check and evaluate the potential effectiveness of the management team. A potential angel investor must verify the founder's experience, and track record with previous startups, and anything that proves/disproves the founder(s) is going to know how to maneuver the boat. Anyone can steer a ship but it takes good leadership to chart the course.

🦞 Strategic relationships in its core market

Not only for B2B businesses but also in B2C ones, the existing and potential partnerships the startup may have to expand and leverage their business will play a crucial role in their success. What are the synergies the startup is exploiting already? what are the potential ones?

🐑 Production and consequent sales (product rollout)

The production & product rollout of a startup is paramount to its progress or failure. It depends on multiple factors such as the total addressable market, the ability of the startup to market and sell their product, and once sold the ability to provide consistent and high-quality support.

Example

Like in the Scorecard Valuation blog post we are now founders of a computer vision-assisted streaming platform called EyeCaramba. I should never get the task of naming a startup because my mind will always drift toward finding the weak pun 😬.

Since we are first-time founders and the Berkus method relies solely on qualitative methods and heavily on the evaluator's expertise and experience, we ask our angel-investor friend to provide us with a ballpark pre-money valuation of EyeCaramba.

After careful consideration our friend gives us the following table:

Value Driver Pre-money valuation range Value
Basic value (idea) €0-500.000 €400.000
Technology €0-500.000 €250.000
Execution €0-500.000 €75.000
Strategic relationships €0-500.000 €275.000
Production and sales €0-500.000 €160.000

Our friend knows we're first-time founders and we might struggle with management, that's why he gave us a lower score in Execution. However he is aware of the huge value of the idea and how the gaming industry is white-hot nowadays, with worse startup ideas getting funded, that's why he assigned the highest value to the Basic value (idea).

Adding up the values of all the factors the final pre-money valuation of EyeCaramba is €400.000 + €250.000 + €75.000 + €275.000 + €160.000 = 1160000 (€1.16M). Niet Slecht.

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References

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