The Cost Method for Early - Stage Valuation
A simple valuation approach based on your development costs and goodwill.
In the earliest stages of developing an invention, valuation often begins with something very down-to-earth: the money, time, and effort you've already put into bringing your idea to life. Before revenue, before investors, and long before complex financial models, the cost method offers a simple and practical starting point. It helps you anchor the value of your invention in the real costs you've incurred — from materials and labour to patents and company formation. In this way, it provides a clear, grounded baseline from which more advanced valuation methods can later build.
If you prefer a quicker, less technical approach to arrive at an initial estimate, I can point to a set of practical shortcuts. See Quick Valuation Methods for five simple techniques that can give you a fast, hands-on sense of value. These shortcuts do, however, assume that some level of revenue or market traction is already visible. If you have no revenue at all, the cost method remains the most straightforward way to establish a baseline value—especially if you want to avoid more complex models.
So, the cost method is a method for the valuation of an invention in a startup based on the incurred costs. This is by far the simplest way for valuing a business and is often used when there is not much prospect of actual production and commercialization. This valuation method is based on the total costs you have incurred so far for the development of your idea, plus an amount for goodwill. Let's delve into this further.
How does the cost method work
Of course, your invention, the iCic, didn't work all at once; you had to make a whopping 40 prototypes before achieving a workable result. To simplify, we divide the costs as follows:
- Material costs,
- Labor costs,
- Patent costs,
- Company formation costs.
Material Costs
The casing of the box, buttons, and the lens it contains didn't cost much, let's say $15, but the circuit board in the box cost no less than $1,000 each, including shipping costs. You know that in mass production, these costs can be reduced to a tenth of that amount, but that's not relevant now. So, the total material costs are:
40 * ($15 + $1,000) = $40,600
Labor Costs
Furthermore, you invested two years of time in your invention, after working hours of your daily job, on weekends, and during vacations (all to the displeasure of your partner). For simplicity, let's say you worked an average of three hours per day. We'll set your hourly rate at $100, resulting in labor costs of:
2 years * 365 days * 3 hours * $100 = $219,000
Patent Costs
Of course, you ensured that a number of patent applications were filed and granted based on your invention. As mentioned elsewhere on this site, you can expect an average cost of $10,000 for a patent. If we also want to protect the invention in other countries, the total quickly adds up to $40,000.
Company Formation
Regarding the formation of a company, it's discussed elsewhere on this site; we repeat that the costs are around $1,000.
In summary, we get:
- Material: $40,600
- Labor: $219,000
- Patents: $40,000
- Company Formation: $1,000
- Total: $300,600
This is your initial valuation. All added up, we arrive at a value of around $305,000 (rounded in your favor, of course). But is that a good valuation?
You know the prototype works in the garage, and don't forget that the invention itself (projecting images on curved glass) carries inherent additional value. We'll conveniently categorize this extra value under Goodwill. Goodwill is a term from the accounting world, and many definitions exist. In this text, we define Goodwill as the additional value that can be attributed to a company because it is able to earn more money than competitors in a similar industry. In practice, this means that something about your invention or business — its technology, brand, know-how, or market position — allows you to generate higher profits than others who offer similar products. If you want to understand this concept more deeply, see Equity, Goodwill & Startup Valuation. In the case of your invention, the iCic, this is almost impossible for you to determine, as you haven't encountered such technology before.
Since we completely made up the iCic, we won't attempt to assign a value to the goodwill. Be cautious, though, as in some cases this additional value can easily amount to millions — for example when an invention gives you a genuine competitive edge that others cannot match. But as mentioned, the cost method presented here should only be used if your invention is still in its infancy and many important questions remain unanswered. But the person you are negotiating with cannot determine the goodwill themselves, so it depends on your negotiation skills and persuasiveness what you can get out of it for goodwill :-). And now, before we move on to more complex valuation methods, it's important to say something about the value of money over time.