The scorecard valuation method is a popular, pre-money valuation method for early-stage startups. In this method, a startup is valued based on an adjusted benchmark value. The central idea is that a startup should be valued in line with comparable startups (similar in terms of geographical location, industry, market potential, and development stage). Next, the benchmark value is adjusted to reflect important nuances that justify a lower or higher valuation.
The Scorecard valuation Method: Fundamentals
The scorecard valuation method was first formulated in 2001 by Bill Payne, a US-based angel investor and startup mentor. It is also known as the Bill Payne valuation method. Like the Berkus Method of valuation, the Scorecard method does not rely on the startup’s financial projections because young startups often fail to meet their financial targets. Instead, the scorecard valuation method compares the target company to similar companies on the following 7 parameters.
- Strength of the Management Team (0-30%)
- Size of the Opportunity (0-25%)
- Product/Technology (0-15%)
- Competitive Environment (0-10%)
- Marketing/Sales Channels/Partnerships (0-10%)
- Need for additional investment (0%-5%)
- Other (0%-5%)
These factors are ranked from most important to the least important. The strength of the management team and the size of the opportunity are the dominant factors and together account for a maximum of 55% of the total valuation. In contrast, the requirement for additional funding only accounts for 5%.
The method can be used to value pre-seed companies, except for companies that operate in capital-intensive sectors, such as biotech and technology companies with a hardware focus.
Application of the Scorecard Valuation Method in Excel
The starting point for the scorecard method is finding the average pre-money valuation of companies that are comparable to your startup. By collecting relevant pre-money valuations and averaging them, a benchmark value is established. Unfortunately, this is also by far the most difficult step.
The average pre-money valuation of pre-revenue companies in a region is key to the scorecard valuation method. But how do you select an appropriate pre-money valuation benchmark? The value needs to be representative of the region, industry, market size, and stage of development of the startup. In addition, the stage of the current economic cycle will also affect the pre-money valuation.
- According to an analysis performed by KPMG, the global median pre-money valuation for an angel investment is $3.6 million as of 31/12/2021. However, in the US, the Americas, and Asia the value is roughly $4.5 million while Europe’s median at $3.3 million is slightly below the global median value.
- These valuations appear to be quite high relative to historical valuations for pre-revenue companies. This is partially explained by the post-covid valuations boom, the increasing competition among investors for promising early-stage investments, and the amount of dry powder that is awaiting deployment by VC/PE firms. Dry powder is the number of funds that have been committed to VC/PE firms but that have not been deployed yet.
You could try to find a relevant pre-money valuation mean or median from industry reports, such as Pitchbook’s Annual US VC Valuations Report 2021. Alternatively, an excellent resource to find pre-money valuations on individual companies is Crunchbase. Unfortunately, the pre-money valuations are behind a paywall for which you require an annual pro subscription and good research skills.
Let’s say that your research resulted in four pre-money valuations of comparable companies. We now take the average of these values to arrive at a benchmark pre-money value, for example, $3,000,000. If you are unable to find pre-money valuations of competitors, you could use the mean or median from industry reports as the benchmark value.
Next, you need to adjust the benchmark value based on your appraisal of some qualitative factors. This requires you to first determine the adjustment factor.
- Recall that the scorecard valuation method is based on 7 parameters that are ranked in order of importance. Each of the parameters has a maximum theoretic weight, e.g. the strength of the management team accounts for a maximum of 30%, the size of the opportunity for 25%, etc.
- The actual weight you assign to these parameters is one of the subjective inputs to this model. For example, if you believe the strength of the management team doesn’t deserve the full 30% weight, it can be lowered from 30% to 25%. Note that the actual weights don’t need to add up to 100% because if you lower the weight of one of the parameters, the weight attached to the remaining parameters cannot exceed their maximum level. In other words, the sum of the actual weights would drop below 100%.
- The target company impact assessment is based on a valuation worksheet where several issues and their impact are listed. The impact can vary from very positive (+++) to very negative (—). Some elements, such as the coachability of the founder, whether the CEO is willing to step down if necessary, and the lack of intellectual property are deal-breakers.
- The worksheet also does not state how you need to calculate the aggregate impact of each parameter. In the end, you need to make a call whether you believe the company scores better or worse relative to its peers. 100% meaning you are at par with the benchmark.
- By multiplying column X with column Y, we find the factor strength for each parameter. Then, you need to add the factor strengths to arrive at the adjustment factor for your company.
Last, we need to multiply the average pre-money valuation benchmark by the adjustment factor. When we multiply $3,000,000 by 0.85, we arrive at a pre-money valuation of $2,542,500 for the Company (minor difference due to rounding). In our example, the pre-money valuation is below the pre-money valuation of peers. This could be attributable to the fact that we are targeting a smaller niche market.
Ultimately, the scorecard method results in a pre-money valuation for your company. This valuation cap can be embedded into a SAFE agreement (Simple Agreement for Future Equity) or a convertible instrument. The valuation caps determine the level at which these financial instruments will convert into equity. However, the valuation cap is often set on a post-money basis instead of on a pre-money basis. The difference between pre-money and post-money valuation caps often leads to confusion since the legal wording of the documents is not clear. Nevertheless, this topic is outside of the scope of the current article and will be covered in an upcoming blog post.
The advantages and disadvantages of the scorecard valuation method
The strengths of the method are:
- A ballpark valuation can be arrived at quickly and easily using the scorecard valuation method. Both founders and early-stage investors can use the scorecard method to value startups or pre-revenue companies.
- A worksheet exists to provide the appraiser with guidance in calculating the impact factors. The worksheet helps remove some ambiguity and leads to more consistency in appraising startups and pre-revenue companies. The questions also draw attention to important issues that often exist in startups and SMEs
The weaknesses of the method are:
- The pre-money valuations of competitors, the starting point of the scorecard valuation method, might be difficult to get because the information is not publicly available. In other words, the valuation calculation might already be a bit off from the very start.
- Like the Berkus method, the scorecard valuation method is a subjective valuation method since the weight attached to the factor and the target company impact multiplier are both subjective inputs.
- While there is something to be said about a qualitative appraisal of pre-revenue companies instead of a quantitative approach, this valuation method does not replace the need for financial projections. Sound financial projections remain essential for any startup company if they wish to succeed in the long term. Every startup needs to understand how it will make money and what its funding requirements are. If not, they might unknowingly be losing a lot of money or go out of business.
Summary
The scorecard method is a valuation method for startups and pre-revenue companies. The company gets appraised by determining a pre-money valuation for comparable startups and adjusting the benchmark value by an adjustment factor. The adjustment factor is the sum of an assessment of 7 valuation parameters. This results in a pre-money valuation for your startup.
The scorecard method is a qualitative valuation technique that can be performed easily and quickly. However, the biggest drawback of the method is that every input is prone to subjectivity. While the worksheet provides guidance, professional appraisers would benefit from applying the scorecard method in a very methodological way within their organizations to maintain a consistent approach.
