2022 Comprehensive Guide on Berkus Valuation Method
Updated: Nov 8, 2022
The Berkus Valuation Method is one of the most used valuation methods in the VC industry. The method was developed by David Berkus, a well-known venture capitalist, and is based on the principle that a company is worth the sum of its parts. The method uses five factors to arrive at a valuation, including the company's sound idea, working prototype, quality management team, strategic relationships, and product rollout or sales. The Berkus Method is a simple and effective way to value a startup company and is often used in conjunction with other methods to arrive at a more accurate valuation.
Table of Contents
What is the Berkus Valuation Method?
The Berkus Valuation Method is a method for valuing Pre-revenue startup companies. It is based on the following factors:
The quality management team can deliver the best possible solution to its customers.
The idea has already been validated through several small-scale experiments, which have demonstrated its feasibility and value to the business.
There are already strategic relationships in place with key stakeholders who will help make it happen.
Product development has reached a point where there are enough working parts for a prototype or even a pilot run.
Product rollout or sales show how much product (or service) will be sold over time.
The above-mentioned factors are assigned a benchmark value. Each Factor can be assigned a value from $0 to $5,00,000. This will give the total valuation of the startup company from $20 million to $25million. This gives the investor ten times return potential over 5 years of business. You can also select a specific company for benchmark or calculate the industry average by studying their data and taking 20% of the value for each factor.
How to Perform Berkus Valuation Method?
Check the parameters of the startup company as discussed below:
Quality management team - This is a group of people who manage the quality of the product. They include employees and suppliers. The quality management team defines quality standards for products and services and monitors their implementation.
You need a strong team who can work together effectively and deliver results on time or early - in other words, they must be able to get things done! These people must have experience in their field so that they know what will work best for them.
A sound idea- This should be an innovative idea that makes sense commercially. It must also be feasible technically, socially, and economically and should not violate any laws or regulations. There are many ways that you can do this including brainstorming ideas with colleagues or using existing products as inspiration for what might work best in terms of design or function.
Working Prototype (WIP)- This is a product that is designed to work as intended after it has been developed or modified based on feedback from customers or users. It can be assessed in the field before commercialization so that problems can be identified early on in its development process.
Strategic relationships- These are relationships with key stakeholders such as suppliers, distributors, financial institutions, etc., which help companies improve their competitive position by getting better pricing terms from them; accessing exclusive deals from them; increasing their marketing reach through them; gaining access to new markets through them.
Product Rollout or Sales- This variable measures how much product (or service) will be sold over time. It includes all costs related to bringing new products or services into production, such as research and development costs, marketing expenditures, manufacturing costs, etc., as well as any other expenses associated with launching new offerings into customers' hands (e.g., shipping). If there is enough demand for this product, then it should have a high ROI potential -- meaning higher profits per dollar spent on advertising campaigns designed around promoting its existence.
Formula Used for Berkus Valuation Method
Pre-money Valuation = assigned value of quality management team + sound idea + Working Prototype + strategic relationships + product rollout or sales
Why Berkus Valuation Method is Important?
Berkus Valuation Method is important for startup companies that are in the early stage and lack pre-revenues. It gives a study about the idea, team, prototype, relations, and sales and whether they will take the startup ahead. It is helpful to give a quick overview of the startup when you have many options and want to select a few for investing (for VCs and Investment banks).
Advantages of the Berkus Valuation Method
The following are some of the advantages of using this method:
It is easy to use and understand. You can use it with little training or experience, so it is great for beginners who want an easier way than using cash flow or net current assets ratios.
It is quick—you only need to put inputs for each factor and then add up all their totals together.
Saves time and effort – Easy Calculation, there is not much math involved here so even if someone does not have much knowledge about accounting terms, they will still be able to do it. Anyone can understand them quickly without having any prior knowledge about business valuation techniques at all!
It does not require much data about comparing companies in a similar industry.
Disadvantages of the Berkus Valuation Method
The following are some of the disadvantages of using this method:
The Berkus valuation method cannot be applied to all companies. It may not apply to companies with different geographical locations. It is not applicable for companies that are listed on the stock exchange and whose shares are traded on the stock exchange.
It cannot be used as a standalone method for valuation.
It may not be accurate as it does not consider many economic factors.
Conclusion
Berkus Valuation Method is a simple method for beginners. This method should be considered only for seed or early-stage startup companies. The benchmark values should be assigned carefully as they can mislead the valuation of the company. Comparable companies in a similar industry should be selected only when they are closely related to the startup. It is better to use other methods of valuation in conjunction with this method.