This is probably the most difficult and emotional aspect for the founders of a company. On the one hand, the founders want the highest possible pre money valuation as proof of the concept and reward for their hard work. It also feeds the high esteem of high testosterone (and/or estrogen) levels of the founders.
On the other hand, a high pre-money valuation can kill any possibility of getting funding. For pre-revenue companies there is no way to mathematically derive a present money value. The Discounted Cash Flow (DCF) method fails because you are constantly dividing by zero. So how does an early seed stage investor arrive at a pre money valuation? First, analyze the revenue and EBITDA projections of the founders. This will provide the investor with some comic relief. Second, construct your own private revenue projections; this can include “ancillary” businesses or using other revenue models. If these revenue projections provide the investor with a 10 bagger (i.e. 10 times the investment) then this is a candidate for investment.
The next step is to construct a pre-money valuation number. I like to back into this with a mathematical formula. The founders need to give up 20 to 30% of the company for the total amount of the money raised in the Angel round. For example, if the founders can raise $200K then the company is worth $1 million. If the same company can raise $1 million then the company is worth around $5 million. Because the company has an additional $800K to work with the risk is much lower.
In essence, instead of trying to calculate a value for a startup (which is impossible), the above scheme attempts to manage the risk of Angel investing. First, the company has to have a potential of at least a ten bagger (whether the company will sell for $10 million, $100 million or $I billion is not relevant). Second, a standard non emotional formula is applied based on amount of funding obtained.
For companies with revenues, later stage Angels can find many other sources on valuing companies.