Figuring out just how much your business idea is worth is a subject of much debate.
Whether you’re looking to sell it to someone or get investment to actually start it- or to ‘pay’ business partners or co-founders in equity. I’m confronted daily with questions of value by eager, aspiring entrepreneurs. There are so many amazing ideas out there and I’m excited by all of the energy & passion behind so many of them.
Now, of course, putting a value on that idea can be a challenging proposition, especially when it comes to raising capital. Is it an idea that you’ve scribbled onto a cocktail napkin- which has little value in my book so don’t even come talk to me. Or, is it something you’ve taken the time to scope out in detail- which has more substance? Even if it’s the latter, how capable are you in making that idea happen. (Hint: think about your experience level.) The more capable you are in execution, the more valuable your idea is.
For example, if you’ve watched Shark Tank, you might see an entrepreneur willing to sell 1/3 of his or her company for $100k. That means the value of the idea is about $300,000. Conversely, you might see a $100k investment for a 10% equity stake, which puts the valuation at $1,000,000- a much more valuable ‘idea’.
I used to work briefly in the Valuation group at PriceWaterhouse and there are many complicated formulas for deriving value, from discounted cash flow analyses (DCFs) to a market comparables approach, however, those are typically used for existing businesses. That approach can be a difficult sell for the budding entrepreneur trying to assess the value of his or her idea, especially when approaching investors for money. I’ve been inspired by Dave Berkus, chairman of Tech Coast Angels, who developed a guideline “Placing a Value on Your Business”. I believe there is a lot of merit to his approach in valuing an early stage business.
In short, consider the following “Berkus Method” to derive value:
- The Idea: Attribute up to $500,000 for the attractiveness of an idea to a potential investor. (Hint: If it’s an innovative idea that has significant growth potential, you’re getting closer to a $500,000.)
- Solid Management: Attribute up to $500,000 for a good management team with experience that’s in place to execute the plan in the early stages of growth. (Hint: You or partners know the industry.)
- Completed “Prototype”: Attributed up to $500,000 for working version of the product— having an appreciative Customer base will only help to add value, too.
- Strategic Relationships: Attribute up to $500,000 for strategic Customer or vendor alliances that will increase barriers to entry for competitors to create value for your idea.
In summary, an idea can have “value” of up to $2,000,000. For example, when I first had the idea for NuKitchen (a healthy meal delivery) and wanted to raise equity investment, I needed to come up with a value for my idea that would be appreciated and understood by potential investors.
Using the Berkus Method, I applied the following values at that time:
- The Idea: $500,000. NuKitchen was an innovative, online venture that’s scalable and targeted a growing segment of health-conscious, time-starved professionals who wanted to eat right.
- Solid Management: $500,000. I am a successful and proven entrepreneur with a track record. I also recruited 2 partners in the culinary and technology space to execute for added credibility.
- Completed Prototype: $250,000. I had just launched the NuKitchen order management platform in a test or ‘beta’ phase, I had a working version (which is patent pending), however, I didn’t have a large customer base at that time so I didn’t give myself a full $500,000 credit.
- Strategic Relationships: $0. At that time, when I started, I didn’t have any strategic partnerships in place, so I didn’t give myself any of the $500,000 credit.)
In summary, I valued my idea at $1,250,000. At the end of the day, regardless of what value I placed on the business, I had to make sure that potential investors would believe in me and my assessment. Based on my experience, I felt that $1,250,000 was the value for my idea and I could justify it.
So, I encourage you to read his work on the “Berkus Method” if you want an in-depth understanding of valuation and how you might apply the principles to your own business idea.