Approaches to Venture Studio Valuations

Disclaimer: nothing here should be taken as financial or investment advice!

The Problem

Many of the established approaches of valuing traditional venture-backed startups are not well suited to venture studio portfolios.

Therefore, it is hard for venture studios to track and report on the total value of all the startup companies they are developing to their LPs and other stakeholders.

For those venture studios that are mandated to use an independent, 3rd-party valuation company (e.g. to provide an annual portfolio valuation for a fund), that 3rd-party will typically only include those companies that have already spun-out from the venture studio and raised money.

Potentially, this massively undervalues the venture studio, or studio fund, since, in the early days, the majority of the value might be in very early startups the studio is developing.

Why Does the Problem Exist?

Note: my perspective is heavily skewed towards US accounting and tax regulations, and also the specifics of Platform’s structure (dual-entity) and Platform’s methodology. However, based on prior conversations with other studio founders, I don’t believe that this problem is unique to the US or Platform.

In my view, the problem exists for a few reasons:

• Established valuation methodologies for startups are strongly linked to venture capital investment which for many studios, is the end of their process.

• More specifically, many established valuation methodologies are based on metrics like revenue and revenue growth rate which can swing wildly in the earliest stages of startup monetization, yielding nonsensical results.

• To minimize costs, many venture studios deliberately defer spinning out a separate legal entity for a startup as long as possible. Therefore, a venture studio can have multiple, revenue-generating “startups” that are not true companies that can be valued independently - they are simply projects inside the studio.

• Accounting standards (GAAP, etc) have not kept up with the surge in the use of SAFE notes for fundraising. From an accounting perspective, SAFEs are typically viewed as liabilities on the balance sheet of a startup. Also, SAFEs may have a post-money cap but do not truly generate a “pricing event” since, even with a post-money cap, the true price is not known until conversion. Yet, SAFEs now represent the majority of Seed stage investment, per Carta’s latest report.

Possible Solutions

Introduction

I don’t think a revolution is required here. Instead, I think a number of the established valuation approaches can be tweaked to be more applicable to venture studio portfolios.

In any case, it is the norm to combine multiple valuation approaches to “triangulate” on a valuation or valuation range.

Below, I review a number of the established valuation approaches and discuss possible variations and modifications.

Method 1: Revenue and Growth Rate

This approach multiplies a startup’s annual growth rate by a multiplier (which is market and industry sector dependent) and then by the startup’s annual revenue growth rate.

i.e. valuation = trailing annual revenue * multiplier * annual revenue growth rate

For example, if the appropriate multiplier is 10 (more a 2021 number than a 2024 number!) and a company is doing $1M in ARR and growing 3x annually, the valuation would be:

1 * 10 * 3 = $30M

There are two big problems for a venture studio:

1. Many studio startups will be pre-revenue.
2. In the early days of monetization, there will be very limited history, small numbers, and wild swings.

To address #2, it’s possible to use, say, the last 3 months of revenue. You would take the latest MRR, multiply it by 12 to get an ARR run rate and average the month-over-month growth rate and then annualize that growth rate (i.e. raise the monthly growth rate to the power of 12).

However, this can yield nonsensical results. A very early-stage startup may have 20x or 30x growth month-over-month in the earliest stages which, when annualized, yields a huge number.

We had one portfolio company that was valued at over a trillion dollars using this method because the annualized growth rate was so extreme.

My thoughts here are to use this approach only as follows:

• Either, only use it when you have enough revenue history - say 6 months of monetization, and/or
• Cap the growth rate to a maximum - say 5x - since anything beyond that is highly unlikely to be sustained

Method 2: Scorecard Method / introducing the “Burton Valuation Method”

To cut to the chase, this is the method that I think works best in most cases for very early-stage venture studio initiatives.

In traditional venture capital, a commonly cited scorecard method is the “Berkus Valuation Method” (https://eqvista.com/berkus-valuation-method-for-startups/).

In this method, a $ value or $ range is attributed to overcoming each of the major risk factors that, when added together, yield a rough valuation.

In the Berkus method, the following risk factors are used:

• Sound Idea
• Quality Management Team
• Prototype
• Strategic Relationships
• Product Rollout or Sale

These are a good start but a. I think we need to be more fine-grained for studio initiatives and b. some of these don’t map to our studio model.

For example, outside of the solo founder we are typically working with, “the management team” is the studio team.

Here are the milestones I currently use in my scorecard:

• Founder Hired
• Product Works (NPS > 20)
• M-o-M Retention > 90%
• > 0 Paying Users
• Average M-o-M Revenue Growth > 10%
• CACD < 12 months
• Raised Angel Investment (> $50K in from external investors)

My approach is to divide the median current seed valuation by the number of milestones (8). By adding up the milestones achieved, one can calculate the valuation as a proportion of a seed stage valuation.

The current median seed stage valuation per the latest Carta report (https://carta.com/blog/early-stage-rounds-rising-q3-2023/) is $14.4M. So, each milestone correlates to $1.8M in valuation.

e.g. if a company has achieved 4 of the 8 milestones on my list, it is valued at 4 * 1.8M = $7.2M

Note: I am giving each milestone equal value currently since there are enough milestones that it doesn’t make a big difference but, like the Berkus Method, it could be argued that the milestones should have different values.

The Berkus Valuation Method is named after Dave Berkus (https://en.wikipedia.org/wiki/Dave_Berkus).

My last name also begins with “B” so I’m taking the liberty of calling my scorecard the “Burton Valuation Method” 🙂

Method 3: SAFE Note Valuations

As mentioned above, per the latest Carta report, SAFE note investments now represent the majority of Seed stage investments.

In some ways, this is simply because SAFEs are easier - it’s a standard template and there is no need to coordinate closing with other investors.

However, it also shows that investors are unsure of where the market is going and don’t want to set a price that they’ll later regret.

Almost all the pre-seed fundraising we do for our companies is in the form of SAFE notes. Most of those SAFE notes have a post-money valuation cap. Sometimes they have a discount. Rarely, do they have both a cap and a discount.

The challenge with the standard SAFE is that the actual future dilution is not known. If the valuation of the next priced round ends up being lower than the cap on the SAFE, the new investor is entitled to the lower price.

Therefore, it’s impossible for the studio (and founder) to know for sure what % of the company it will own when the next priced round happens. You only know the maximum you’ll own. Of course, this makes valuation tough.

Further, from an accounting perspective, SAFE notes are generally treated as liabilities on the balance sheet versus investor capital for equity.

Still, I believe that SAFE note caps can and should be used as a proxy for startup valuation. Yes, there is the possibility of a priced round that is below the cap but that is less likely unless the cap is too high and/or the market is in decline. One would expect that a market of reasonably intelligent and self-interested investors will make the former unlikely except for a few outliers and the latter is something that can be taken into account with a discount based on where the market is going.

Therefore, I use the most recent SAFE note cap as one of the valuation methods in my assessment, where available.

Method 4: Discounted Comparables

In this method, we look at comparable companies that have reliable valuations - from IPOs, M&A, or late-stage rounds - and work backward to what they would have been valued at the same point in their journey as the startup to be valued.

You may see a discussion of “discounted future cash flows” or “discounted cash flow” (DCF). The challenge with a very early-stage startup is that it’s extremely hard to predict future cash flows. So, the discounted comparables method I outline here works by discounting the valuation of a comparable company rather than the cash flows of the startup.

As inputs, this method takes:

• each comparable company's valuation at exit or last priced investment round (their 'terminal value'), and
• the length of time elapsed from founding to the pricing event (their "terminal duration").

The terminal value is inflation-adjusted to today’s value.

We then treat the terminal value of the comparable company as the future value of the relevant portfolio company and discount that valuation to present value, for the number of years that the comparable company took to achieve that valuation, minus the time the portfolio company has already been in existence.

i.e. Valuation = Terminal Value / (1 + Rate of Return) ^ (Terminal Duration - Age of Startup)

We expect the valuation of a startup to grow quickly, so the Rate of Return used is typically pretty large. I run it with 50%, 70%, and 90% to give a range.

Of course, by selecting startups that have achieved an exit, there is a survivorship bias. In some write-ups, you’ll see the “survival rate” and “discount rate” broken out separately.

However, you simply end up multiplying the survival rate by the discount rate, so, for simplicity, I am combining both into the Rate of Return.

An Example

Ok - it’s easier with an example:

I have a portfolio company that is in the housing space.

I use Airbnb as a comparable (in practice, I will use multiple comparables to give a range).

From public records, I can see that, in 2020, Airbnb sold 51.5M shares at $68/share. i.e. the IPO raised $3.502B.

The float was 64.9% of the total outstanding shares, so the total enterprise value at IPO can be said to be about $5.4BN.

Now, I adjust that value to today’s dollars and it is about $6.4B. i.e. at IPO, Airbnb was worth $6.4B in 2024 dollars. This is the “Terminal Valuation”.

Also from public sources, I can also see that Airbnb was founded in 2007, so it took 13 years for Airbnb to achieve that $6.4B. So the “Terminal Duration” is 13 years.

My portfolio company I’m valuing is 2 years old.

So, now I can run the math. I’ll use a 70% rate of return for this example (the midpoint in my range):

Valuation = $6.4B / (1 + 70%) ^ (13 - 2) = $18.7M

Method 5: Cost to Replicate

This is an established method for early stage startup valuation, particularly in the context of M&A. It amounts to assessing how much it would cost someone else to reproduce the same company, including the same product.

It’s also arguably a natural model for many venture studios, especially those that originated as professional services companies, since they are very used to thinking about, and accounting for, the cost to build things.

However, I don’t think it’s a particularly useful method for valuing studio startups other than perhaps setting a lower bound. This is because the value of a studio is very often in its ability to create better solutions, and more quickly, than most or all traditional founding teams.

The know-how, process, stage gates, reusable components, patterns, etc developed by the studio mean that it has likely developed something that an average founding team would spend much longer developing, with many more wrong turns, and errors.

In Summary

I suggest that studio teams try multiple methods to value their portfolio companies and report ranges.

I personally think that the Scorecard Method (#2 above) presents the best way to value the earliest initiatives - i.e. those that are not spun out independently from the studio and/or are pre-revenue.