The risk factor summation method starts from a benchmark valuation and moves it up or down in fixed steps for each of twelve categories of risk, making every adjustment explicit.
10 min read · Level 3
I think this method earns its place by what it makes you look at, not by the precision of its answer. Twelve categories is enough that you cannot skip the uncomfortable ones, and a -2 written next to a reason is harder to forget than a vague worry.
Risk factor summation starts with a benchmark pre-money for comparable companies, then judges twelve risks. Each is rated from -2 (very high risk) to +2 (very low risk), and each point moves the valuation by a fixed amount, often 250,000.
Risk Rating Management +1 Stage of the business 0 Legislation or political -1 Manufacturing 0 Sales and marketing +1 Funding and capital raising -1 Competition -2 Technology +1 Litigation 0 International 0 Reputation +1 Potential lucrative exit +1 Net +1
With a benchmark of 3,000,000 and 250,000 per point:
Pre-money = 3,000,000 + (1 x 250,000) = 3,250,000
The net number hides the detail: this company has strong management and technology, but faces serious competition and regulatory exposure.
Because it forces an investor to consider risks they might otherwise skip - litigation, legislation, international exposure - and to state each judgement.
The list of ratings is often more useful than the valuation: the -2s and -1s are the questions diligence should answer.
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Diligence changes one rating.
After speaking to a regulator and a specialist lawyer, the investor finds the legislation risk is lower than feared and moves it from -1 to +1. The net rises from +1 to +3:
Pre-money = 3,000,000 + (3 x 250,000) = 3,750,000
The 500,000 increase is attached to one specific finding, which is easy to explain to co-investors and to the founder.
Rating every risk 0 by default because information is missing. An unknown risk is not a neutral one; it is a question that should be answered before investing.
Use a relevant pre-money benchmark and a step size suited to the local market.
Rate from -2 to +2 and record the reason.
Add the ratings and multiply by the step size.
Investigate the risks rated -1 and -2 before deciding.
When pricing an early company and wanting a structured list of risks alongside a valuation.
Do not treat the ratings as independent or exhaustive; some risks overlap and a single severe risk can matter more than the sum suggests.
Angel investor associations and valuation guides have commonly presented risk factor summation alongside the scorecard and Berkus methods as tools for pre-revenue companies, typically suggesting investors use several methods and compare the results.
No single pre-revenue method is treated as definitive; they are used together.
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