What Is The Risk Factor Summation Method For Startup Company Valuation?
The Risk Factor Summation Method (RFSM) For Startup Company Valuation was formulated by Ohio TechAngels.
Compared with the scorecard and Berkus methods, the RFSM considers a more extensive list of important factors for assessing a startup's value in a pre-revenue stage. The risk factor summation method includes different exogenous risk factors that a company should manage to get a profitable "exit" from the investment.
The main disadvantage of the Risk Factor Summation Method is the fact that the method is market-oriented.
The first step in implementing the Risk Factor Summation Method is assessing the average pre-money valuation of pre-revenue young companies operating in the same sector and geographical area.
In the second step, the RFSM presents a list of possible risks associated with startups and their sectors, such as the stage of business, management risk, manufacturing risk, legislation/political risk, sales and marketing risk, funding and capital raising risk, competition risk, technology risk, litigation risk, international risk, reputation risk, and a potentially lucrative exit.
Each risk factor's weight should be varied according to the importance of the startup's specific factor. Each risk factor is assigned a different rating based on the "correct" average pre-money valuation for comparable companies.
The following table summarizes these estimation parameters, their meaning, and the adjustment that has to be applied to the average pre-money valuation of comparable young companies.
| Rating | Meaning | Average pre-money valuation adjustment |
| 2 | Very positive to grow the business and get an ideal exit | + $ 500,000 |
| 1 | Positive | + $ 250,000 |
| 0 | Neutral | No correction |
| -1 | Negative | - $ 250,000 |
| -2 | Very negative to grow the business and get an ideal exit | - $ 500,000 |
The Risk Factor Summation Method expresses the startup's value according to the following formula:
pre-money valuation = average pre-money valuation for the sector +/- adjustment
Like the Berkus method for startup valuation, the Risk Factor Summation Method shows subjective evaluation signs. Still, the perception of risks is more precise.
The main disadvantage of the Risk Factor Summation Method is the fact that the method is market-oriented. Determination of the average pre-money value of a startup mirrors the sector's situation and in the same geographical area. Moreover, another problem can be the shortage of information related to the region to derive this value.
