Berkus Valuation Method

Let's talk about the Berkus valuation method for startups 

We see a wide variety of methods in evaluating a startup, but one of the best simple, and easiest rule of thumb for pre-revenue startup valuation is the Berkus method.

The Berkus method is a systematic process used for assessing a startup's viability in its early stages. It was named after its inventor Dave Berkus, a well-known Californian angel investor, and is said to be a popular tool in the startup world for determining if a company will succeed.

It's common knowledge that nine out of ten new enterprises fail. Uber, Airbnb, Slack, and other unicorn companies only make up 1% of all startups. For first-time founders, the success rate is 18%. These cold stats are not to discourage any entrepreneurs but in fact, encourage them to work harder and smarter.

The lack of revenue data and the fact that even if the product is on the market, it is nearly always an MVP are some of the biggest difficulties for an early-stage start-up valuation.

The basic foundation of evaluating a company lies in revenue and profit projections. Apart from that, reasons like uncertainty, lack of data, assumptions, changes in strategy, and challenges in execution can also be some of the reasons why not all early-stage startups fulfill or outperform their initial final projections, which in turn can affect the accuracy of the quantitative valuation models. 

This is where the Berkus method comes in, it uses both qualitative and quantitative aspects to compute valuation based on five important components to circumvent the problem by quantifying something that isn't quantifiable. The 5 important components are : 

1. Valuable business model  

2. Prototype 

3. Management Valuation 

4. Strategic Relationship 

5. Product Rollout 

The Berkus method evaluates the risk and assigns financial value to the five elements of risk with an initial value of $500K for each element that reduces the risk. Thus the pre-revenue valuation is capped at $2 million, and the post-rollout valuation is capped at $2.5 million. But the investor can assign a lower value resulting in a lower overall valuation.  

As time went by, the original framework was too restrictive and a more flexible strategy was required. Rather than being a rigid form, the approach was subjected to serve as a suggestion now. This approach will be able to prioritize the risk that matters the most, to both the investor and the company and assigns each element a maximum value, based on the conditions and the sector.

To reflect the modern market dynamics the Berkus method has been adjusted, updated, and made flexible enough for the users to negotiate or create a maximum valuation that they are willing to accept in an ideal scenario. Also letting them assign risk factors that may be more significant to them than the ones listed above.

The Berkus Method is still a helpful tool for valuing businesses, particularly early-stage businesses, despite its drawbacks. It is an easy method for quickly estimating a company's value without having to be too familiar with its financials.