The discounted cash flow (DCF) method is commonly used to value established businesses, but it can also be adapted to value pre-revenue stage startups. It requires careful consideration of key parameters to address the pre-revenue stage nuances. Here are the steps to use the DCF method to value a pre-revenue stage startup:

1. Develop revenue projections: Since the startup is in its pre-revenue stage, revenue projections will be based on assumptions and estimates. The projections should cover a period of 5-10 years and be based on market research, industry trends, and the startup’s competitive advantages.
2. Determine the discount rate: The discount rate is used to convert future cash flows into present value. Since the startup is in its pre-revenue stage and is assumed to be more risky than an established business, the discount rate should be higher than the typical rate used for established businesses. A discount rate of 25-35% is common for pre-revenue stage startups. The below three parameters need to be adjusted to a riskier profile for a pre-revenue stage startup:
   • Beta
   • Size Risk Premium
   • Company Specific Risk
3. Calculate the terminal value: The terminal value represents the estimated value of the startup at the end of the projected period. It can be done in two ways. The third way is not recommended, still mentioned here for the sake of completeness:
   • EBITDA multiple method: This method involves applying a multiple to the projected EBITDA (earnings before interest, taxes, depreciation, and amortization) in the last year of the projection period. Since startups are generally high-growth and high-risk, the EBITDA multiple for a pre-revenue startup is typically lower than for an established business. A multiple of 5-10x is common for pre-revenue stage startups.
   • Market capitalization method: This method involves estimating the startup’s market capitalization at the end of the projection period. This can be done by comparing the startup to similar companies in the industry and applying a multiple to the projected revenue or EBITDA.
   • Terminal Growth Rate (Not recommended) – It is generally not recommended to use a terminal growth rate to calculate the terminal value for a pre-revenue startup in discounted cash flow (DCF) valuation. The terminal growth rate is used to project a long-term growth rate for a mature company, assuming it will continue to grow at a steady rate indefinitely. However, pre-revenue startups are not mature and are often still developing their business models, products, and services. As such, projecting a long-term growth rate based on assumptions about the future can be highly uncertain and unreliable.
4. Discount the cash flows: Using the discount rate determined in step 2, discount the projected cash flows to their present value. This involves dividing each projected cash flow by (1 + discount rate) raised to the power of the year in which the cash flow is received.
5. Calculate the present value of the terminal value: Using the discount rate determined in step 2, calculate the present value of the terminal value by dividing it by (1 + discount rate) raised to the power of the last year in the projected period.
6. Add up the present values: Add up the present values of the projected cash flows and the terminal value to arrive at the total present value of the startup.
7. Adjust for liquidity and risk: Since the startup is not generating revenue, the valuation may need to be adjusted for liquidity and risk. Investors may demand a higher return on investment to compensate for the added risk.

While the DCF method can provide a valuation for a pre-revenue stage startup, it is important to remember that it is based on assumptions and estimates. Investors may also consider other factors such as the startup’s team, market potential, and competition when deciding on an investment.