VALUATION FOR STARTUP COMPANIES Anthony Knobloch, CFA November 14, 2016
EARLY STAGE COMPANIES http: //fundersandfounders. com/how-startup-valuation-works/ Valuation matters to entrepreneurs because it determines the share of the company they have to give away to an investor in exchange for money. At the early stage the value of the company is close to zero, but the valuation has to be a lot higher than that. Why? Let’s say you are looking for a seed investment of around $50, 000 in exchange for about 10% of your company. Typical deal. Your pre-money valuation will be $500, 000. This however, does not mean that your company is worth $500 k now. You probably could not sell it for that amount. Valuation at the early stages is a lot about the growth opportunity rather than a forecast of near term cash flow. Page 2
VALUE AT THE EARLY STAGES OF A COMPANY How much money do you need (and for what time period) to get to significant growth and raise the next round of investment. Let’s say that number is $100, 000, to last you 18 months. So let’s say the amount of the investment is set. How much of the company to give to the investor. So you will probably give away 5 -20% of the company, depending on your valuation. As you see, $100, 000 is set and 5%-20% equity is also set. That puts the (premoney) valuation somewhere between $500, 000 (if you give away 20% of the company for $100, 000) and $2 Million (if you give away 5% of the company for $100, 000). Where will your company land in the range? 1. Depends on how other investors value similar companies. 2. How well you can convince the investor that you will grow fast. Page 4
VALUATION APPROACHES Cost (Asset) Approach Market Approach Every dollar you spend may or may Are there not create an comparable equal dollar of companies? value Page 5 Income Approach Are there current revenues or projections?
WHAT IS OF VALUE? Patents Equipment Historical v Future Revenue Process Page 6 Trademarks
WHAT IS OF VALUE? (simplified) Cash Flow Page 7
COST (ASSET) APPROACH Historical or Future Costs Substitution Absolute Reproduction Page 8 • Cost to obtain or reproduce the asset • Purchase the asset today • Replacing the asset with a substitute of equality • Create a reproduction of the asset • Direct costs: materials, designs, marketing, legal fees, personnel, engineering • Indirect costs: development time, overhead
TECHNOLOGY, TRADEMARKS AND OTHER IP No linear relationship between cost of creating IP and its value Risk of wasted investment is high, but there is upside potential with commercialization IP is commonly licensed - market-based royalty rates Page 9
MARKET APPROACH Active Market Comparable Transactions Most Direct Method – if there are comps available Page 10 • Often necessary to work with less than optimal comparable transactions • Limited data for business owners • Fairly costly databases • Look at the context for the transaction (bankruptcy, divorce, litigation) • Royalty rates
PRIVATE COMPANY TRANSACTIONS BIOTECH Page 11
PUBLIC COMPANY TRANSACTIONS BIOTECH Page 12
PRIVATE COMPANY TRANSACTIONS – INTERNET/SOFTWARE Page 13
PUBLIC COMPANY TRANSACTIONS – INTERNET/SOFTWARE Page 14
INCOME APPROACH Future Benefits • How reliable are the current projections? Page 15 Expert Judgment • What can substantiate growth and customer acquisition rates? Outside Factors • What other economic and industry factors are present?
DISCOUNT RATE STUDIES (1) Plummer, James L. , QED Report on Venture Capital Financial Analysis, Palo Alto: QED Research, Inc. , 1987. (2) Sherlis, Daniel R. and Sahlam, William A. , “A Method for Valuing High-Risk, Long Term, Investments: the Venture Capital Method, ” Harvard Business School Teaching Note 9 -288 -006, Boston: Harvard Business School Publishing, 1989. (3) William A. Sahlman, Howard H. Stevenson, Amar V. Bhide, et al. , “Financing Entrepreneurial Ventures, ” Business Fundamental Series (Boston: Harvard Business School Publishing, 1998). (4) Babson College, William D. Bygrave, June 1997, "Classic Venture Capital in the Next Millennium". Page 16
DISCOUNT RATE STUDIES – cont. Source: 2016 Pepperdine Capital Markets Project Page 17
VALUE DRIVERS • What is the reputation and/or background of the founding members? • How quickly can revenue start? • What is the expected growth? Competition • How large is the potential market? Business Plan • Are there any current competitors? • How are the competitors performing? • Is there a solid business plan? • What are you willing to give up in equity? • Who are your available investors? Founding Team Near-Term Revenues Growth Market Size Page 18
ALTERNATIVE METHODS Venture Capital Method First Chicago Method Berkus Method Page 19
Venture Capital Method Bill Sahlman, Harvard Predict Exit Result Backsolve For Entry Page 20 • Forecast future results • Apply an exit multiple • Estimate likely dilution to that point • Determine share • Convert future value to present using a required ROI or hurdle rate.
First Chicago Method Three projection scenarios • Best, Worst, and Survival • ie. 20% failure, 15% success, 65% survival. • Major benefit of the approach is that you can perform some sensitivity analysis, which helps to articulate risk. • Downside is that you have three projections which all require their own assumptions in addition to an estimate of probability for each Assign Probabilities to each Expected Value Page 21
Berkus Method Dave Berkus – investor, speaker, author Pre-Revenue companies Key Value Metrics Page 22 • Cool idea/concept/tech – 500 k • Experienced management – 500 k • Prototype/build – 250 k • Strategic relationships – 250 k • Board of Directors – 250 k • Paying customers/traction – 500 k – 1 m
OTHER CONSIDERATIONS Capital Structure Complexity Equity Compensation Page 23 • How do you allocate the total value to various preferred/convertible different classes of equity? • Ensuring compliance with 409 A when issuing equity as compensation. • Ensuring GAAP compliance with the recognition of compensation expense with regard to equity and equity options grants.
QUESTIONS? Page 24
THANK YOU! Page 25 Anthony L. Knobloch, CFA Tony@bridgevaluation. com 314 -609 -7236 www. bridgevaluation. com