START-UPBASIC

VALUATIONHOW MUCH ARE YOU WORTH?

INTRODUCTION: DUDE, DON'T FREAK

I KNOW WHAT YOU ARE SAYING…

I KNOW WHAT YOU ARE SAYING…

OH GOD. ANYTHING

BUT FINANCE.

BUT, SERIOUSLY. DON'T SWEAT IT. I KNOW WHAT YOU ARE SAYING…

OH GOD. ANYTHING

BUT FINANCE.

BUT, SERIOUSLY. DON'T SWEAT IT. I KNOW WHAT YOU ARE SAYING…

OH GOD. ANYTHING

BUT FINANCE.FINANCE IS ACTUALLY QUITE SIMPLE

BUT, SERIOUSLY. DON'T SWEAT IT. I KNOW WHAT YOU ARE SAYING…

OH GOD. ANYTHING

BUT FINANCE.FINANCE IS ACTUALLY QUITE SIMPLEWHEN YOU FOCUS ON WHAT MATTERS.

AND YOU CAN'T AVOID IT.

AND YOU CAN'T AVOID IT.BECAUSE IF YOU LOOK WEAK

AND YOU CAN'T AVOID IT.BECAUSE IF YOU LOOK WEAKIF YOU ACTUALLY LET EXCEL KNOW YOU'RE SCARED

AND YOU CAN'T AVOID IT.BECAUSE IF YOU LOOK WEAKIF YOU ACTUALLY LET EXCEL KNOW YOU'RE SCAREDTHEN YOU'LL BE ON

YOUR ASS

SO LET'S TALK ABOUT VALUATION

SO LET'S TALK ABOUT VALUATIONSINCE YOU CAN’T

AVOID IT

SO LET'S TALK ABOUT VALUATIONSINCE YOU CAN’T

AVOID ITSINCE IT'S NOT ACTUALLY

THAT HARD

SO LET'S TALK ABOUT VALUATION

SINCE IT'S NOT ACTUALLY THAT HARD

AND SINCE IT IS ONE OF THOSE TOPICS THAT

ABSATIVELY CANNOT BE DELEGATED TO FINANCE

SINCE YOU CAN’T AVOID IT

VALUATION IS THE PROCESS OF

DEFINING WHAT YOUR START-UP

IS WORTH!DEFI

NIT

ION

DEFI

NIT

ION VALUATION IS

THE PROCESS OF DEFINING WHAT YOUR START-UP

IS WORTH!

YOU DO THAT IN 3 SIMPLE WAYS

DEFI

NIT

ION VALUATION IS

THE PROCESS OF DEFINING WHAT YOUR START-UP

IS WORTH!

YOU DO THAT IN 3 SIMPLE WAYS

YOU'RE WORTH WHAT YOU OWN

DEFI

NIT

ION VALUATION IS

THE PROCESS OF DEFINING WHAT YOUR START-UP

IS WORTH!

YOU DO THAT IN 3 SIMPLE WAYSYOU'RE WORTH WHAT YOU

OWNYOU'RE WORTH WHAT YOU CAN EARN IN THE FUTURE

DEFI

NIT

ION VALUATION IS

THE PROCESS OF DEFINING WHAT YOUR START-UP

IS WORTH!

YOU DO THAT IN 3 SIMPLE WAYSYOU'RE WORTH WHAT YOU

OWNYOU'RE WORTH WHAT YOU CAN EARN IN THE FUTUREYOU'RE WORTH WHAT THE

MARKET SAYS YOU'RE WORTH

LET'S GO THROUGH EACH OF THOSE…

PART 1 YOU'RE WORTH WHAT YOU

OWN

VALUATION BASED ON ACTUAL ASSETS IS PROBABLY THE SIMPLEST

AND MOST INTUITIVE

YOU ARE WORTH EXACTLY HOW MUCH YOU HAVE IN YOUR POCKET!

* (ADVANCED READER: WHAT IS IN YOUR BALANCE SHEET TODAY?)

ACTUALLY, WHAT YOU’RE WORTH RIGHT NOW CAN BE DIVIDED INTO 2

MAJOR CATEGORIES OF VALUE

TANGIBLE ASSETS INTANGIBLE ASSETS

INVENTORYCASH OR FINANCIAL ASSETSBUILDINGS, LAND, VEHICLES, EQUIPMENTCOMPUTERS, DESKS, CHAIRS (ANYTHING YOU CAN HOCK)ACCOUNTS RECEIVABLE (WHAT PEOPLE OWE YOU)AGREEMENTS THAT COULD BE NOVATED (FRANCHIZE OR DISTRIBUTION AGREEMENTS)

COPYRIGHTSPATENTS

TRADEMARKSTRADE SECRETS

BRAND / REPUTATIONUNIQUE KNOWLEDGE

SO THE FIRST THING YOU NEED TO DO IS FIGURE OUT HOW MUCH YOU CAN

SELL ALL THE TANGIBLE & INTANGIBLE ASSETS FOR

BUT…

YOU’LL PROBABLY ALSO HAVE SOME LIABILITIES TOO

RENTAL AGREEMENTSACCOUNTS PAYABLE

BANK LOANSUNPAID SALARY

SALARY LIABILITIES (NOTICE PERIODS)TAX OWED

BONDSLEASES

PENSION CONTRIBUTIONPRODUCT WARRANTIES

OTHER CONTINGENT LIABILITYSHAREHOLDER DEBT

YOU NEED TO SUM UP ALL THESE LIABILITIES AS WELL

AND WHEN YOU DO THAT, YOU’RE READY TO VALUE YOUR FIRM:

FIRM VALUE = (TANGIBLE + INTANGIBLE ASSETS) - LIABILITIES

SIMPLE RIGHT?

WELL SIMPLE COMES AT A COST

OF THE 3 METHODS, THIS RESULTS IN THE LOWEST VALUATION

WHICH IS WHY, IT IS REALLY ONLY USED DURING LIQUIDATIONS

PART 2 YOU'RE WORTH WHAT YOU CAN EARN IN THE FUTURE

OF COURSE THE ASSETS & LIABILITIES METHOD DOES NOT WORK WELL WHEN

YOU ARE PITCHING A TRUE START-UP WHICH HAS NOTHING OTHER THAN A

BIG DREAM

BECAUSE YOU HAVE NO ASSETS

IN THAT CASE, WE NEED TO VALUE THE BUSINESS BASED UPON WHAT IS

POSSIBLE IN THE FUTURE

BUT WAIT? WHY WOULD ANYONE PLACE A VALUE ON POSSIBLE

FUTURE MONEY

WELL IT TURNS OUT THAT POSSIBLE FUTURE MONEY DOES HAVE VALUE

DEPENDING ON HOW POSSIBLE, AND HOW MUCH FUTURE MONEY WE’RE

TALKING ABOUT

THINK OF IT THIS WAY

IF YOUR MOTHER TOLD YOU SHE’D GIVE YOU 20 DOLLARS TOMORROW IF YOU

DID 1 HOUR OF CHORES TODAY, WOULD YOU DO IT?

SURE YOU WOULD

WHAT A GOOD CHILD

YOU TRUST MOM. YOU NEED THE DOUGH TOMORROW. SO YOU’LL PAY IN

ADVANCE

YOU SEE. PROMISED FUTURE MONEY DOES HAVE VALUE TODAY

HOW ABOUT IF A BANK TOLD YOU THAT THEY’D GIVE YOU A GUARANTEED 110

DOLLARS IN A MONTH IF YOU DEPOSITED 100 DOLLARS TODAY?

SURE YOU WOULD

THE POINT IS THAT THERE IS DEFINITELY VALUE TODAY FOR FUTURE MONEY

HOWEVER, THERE IS A LIMIT

THE VALUE OF FUTURE MONEY AND THE VALUE OF MONEY TODAY IS NOT

EQUAL

WOULD YOU PAY ME 100 DOLLARS TODAY IF I PROMISED THAT I’D RETURN

100 DOLLARS IN 10 YEARS?

COME ON…YOU CAN TRUST ME. I’LL PM YOU MY BANK DETAILS

NO, OF COURSE NOT

FIRST, IF YOU DEPOSITED THE 100 BUCKS IN A BANK, YOU’D GET MORE

THAN 100 BACK IN TEN YEARS BECAUSE OF INTEREST

(WELL MAYBE NOT MUCH MORE)

IN OTHER WORDS, THE VALUATION OF FUTURE PROMISED MONEY IS

AFFECTED BY OPPORTUNITY COST

SECOND, WHO’S TO SAY THAT I WON’T RUN OFF WITH YOUR MONEY, OR GET

HIT BY A BUS

SO NOT ONLY MUST WE CONSIDER OPPORTUNITY COSTS, WE MUST ALSO

CONSIDER RISKS

IN OTHER WORDS, FUTURE PROMISED MONEY HAS VALUE TODAY, BUT IT IS

NOT 1 FOR 1 VALUE

FUTURE PROMISED MONEY IS WORTH LESS THAN THE SAME MONEY RIGHT

NOW.

IN OTHER WORDS, FUTURE MONEY NEEDS TO BE DISCOUNTED

FORTUNATELY, AN ARMY OF MATHEMATICIANS WORKED THEIR

MAGIC AND CAME UP WITH A COUPLE OF NIFTY FORMULAS

INTERNAL RATE OF RETURN (IRR) AND

NET PRESENT VALUE (NPV)

(ACTUALLY, IT’S REALLY THE SAME FORMULA, JUST SOLVED FORWARDS AND BACKWARDS)

THESE FORMULAS LOOK AT YOUR FUTURE PROMISED CASH FLOWS, AND

DISCOUNT THEM FOR TODAY

(SOMETIMES WE CALL THIS DISCOUNTED CASH FLOW)

IT IS NOT ACTUALLY HARD MATH, BUT IT ISN’T EASY MATH EITHER

(UNLESS YOU ARE FROM ANYWHERE OUTSIDE OF THE US, IN WHICH CASE, IT IS EASY)

FORTUNATELY, BILL’S BOYS IN THE MS EXCEL TEAM HAVE TAKEN THAT MATH

AND TRANSFORMED IT INTO A VERY SIMPLE FORMULA IN EXCEL WHICH 7 OF

9 CHIMPANZEES CAN USE

THE FORMULA IS:

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

SO, IN ORDER TO USE MS EXCEL TO CALCULATE YOUR START-UP’S VALUE,

YOU NEED TO KNOW:

WHAT IS THE DISCOUNT RATEWHAT ARE THE FUTURE CASH FLOWS

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

GETTING FUTURE CASH FLOWS IS EASY

YOU JUST GRAB THE PROFIT (NOT REVENUE) LINE FOR YOUR NEXT 5

YEARS

(YOU GET THAT IN YOUR PRO-FORMA P&L)

(NOTE FOR ADVANCED USERS: I AM NOT A FAN OF TERMINAL VALUE FOR START-UPS, SO I WON’T COVER IT HERE. I’M ALSO NOT CONSIDERING DEBT SINCE IT IS

A START-UP. CORPORATE TREASURERS NEED TO READ SOMETHING MORE ADVANCED THAN THIS DECK, AS I’M SURE YOU REALIZED ALREADY)

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

CHOOSING THE DISCOUNT RATE HOWEVER, IS SLIGHTLY HARDER

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

(SOMETIMES PEOPLE REFER TO DISCOUNT RATE AS WEIGHTED AVERAGE COST OF CAPITAL OR WACC)

THE DISCOUNT RATE IS A NUMBER FROM 0 TO 1.

THE CLOSER TO 1 YOU GET, THE MORE YOU DISCOUNT

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

SO A DISCOUNT RATE OF .2 (20%) IS NOT VERY RISKY AT ALL, AND A

DISCOUNT RATE OF .8 (80%) IS SUPER RISKY.

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

THE DISCOUNT RATE IS ACTUALLY CALCULATED BASED ON MANY

CRITERIA

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

FOR EXAMPLE…

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

RISKHOW CONFIDENT IS THE INVESTOR

ABOUT THE LIKELIHOOD THE PROFIT YOU FORECASTED WILL ACTUALLY MATERIALIZE (REVENUE AND COST

ASSUMPTIONS ACCURATE?)

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

OPPORTUNITY COSTSHOW MUCH MONEY WOULD THE

INVESTOR MAKE IF SHE INVESTED THE MONEY ELSEWHERE – ESPECIALLY IN

RISK-FREE THINGS LIKE T-BILLS…AND WHAT ABOUT INFLATION…

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

MARKET NORMSTHE DISCOUNT RATE WILL ALSO VARY

FROM MARKET TO MARKET WHERE THE WISDOM OF CROWDS HAS GENERATED

RULES OF THUMB OVER THE YEARS

(IE: PHARMA RATES ARE DIFFERENT FROM E-COMMERCE PORTAL RATES)

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

HOWEVER, HERE IS MY PERSONAL INVESTING RULE OF THUMB,

GENERICALLY

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

PHASE DISCOUNT RATEAngel Round .8Series A .6Series B .4Mezzanine .2

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

IN OTHER WORDS, IF YOU ARE USING A DISCOUNT RATE OF 50% AT THE

IDEA STAGE, I’M JUST NOT GOING TO BITE

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

BECAUSE THERE IS JUST SO MUCH DAMN RISK THAT YOUR FORECASTS

WILL BE WRONG, OR YOU’LL DIE IN EXECUTION

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

AS I NEGOTIATE YOUR DISCOUNT RATE WITH YOU, I’D ALSO BE CONSIDERING A MOTLEY OF

FACTORS…

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

HISTORY OF STABLE GROWTH AND PROFITS

PRODUCT CYCLE POINT

SIZE MARKET SHARE

INDUSTRY

CUSTOMER BASE -DIVERSIFICATION

GROWTH POTENTIAL-TOPLINE AND BOTTOM LINE

TRENDS

COMPETITIVE POSITIONING

PRODUCT MIX

UNIQUENESS

THE VALUE OF SIMILAR COMPANIES

STRATEGY FOR CONTINUED GROWTH AND

PROFITABILITY

TIMING

SO, BY WAY OF EXAMPLE…IMAGINE A FRESH START-UP THAT EXPECTS TO

HAVE PROFIT OVER THE NEXT 5 YEARS OF -250,000, 0, 250,000,

2,000,000, & 10,000,000

=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

USING EXCEL, TODAY’S VALUE OF THIS FIRM’S

FUTURE, PROMISED PROFIT IS $623,719.

THAT MEANS, IF I INVESTED $150K TODAY, I’D GET ~25%

OF THE FIRM

(WHICH MEANS 2.5M RETURN IN YEAR 5 IF WE DISTRIBUTE THE

YEAR 5 PROFIT AND I GET MY 25%)

OK, THAT'S NPV

LET ME QUICKLY MENTION IRR AS WELL SINCE IRR IS QUITE POPULAR

THESE DAYS

AS WE MENTIONED BEFORE, INTERNAL RATE OF RETURN (IRR) IS LIKE STANDING THE NPV FORMULA

ON IT'S HEAD AND SHAKING IT UP AND DOWN

THE IRR IS THE DISCOUNT RATE THAT WOULD MAKE THE NPV ZERO

OR, IN OTHER WORDS, THE IRR IS THE RATE OF EXPECTED GROWTH

THE HIGHER THE IRR, THE BETTER THE INVESTMENT

AGAIN, BILL'S BOYS CAME TO THE RESCUE

=IRR (INVESTMENT, CASH FLOW 1, CASH FLOW 2…)

IN THIS EXAMPLE, WE ASSUME THAT WE INVEST 150K IN A START-UP. THE INVESTMENT LOSES 250K IN YEAR 1, BREAKS EVEN IN YEAR

2, MAKES 250K IN YEAR 3, 2M IN YEAR 4 AND EXITS IN YEAR 5 FOR

10M

GIVEN THIS, THE INVESTOR IRR IS 127.5%

IN OTHER WORDS, WE EXPECT THIS INVESTMENT TO GROW 127.5%.

MUCH BETTER THAN A SAVINGS ACCOUNT!

SO….UH…WHICH DO YOU USE: IRR OR NPV?

HONESTLY, IT DEPENDS ON THE AUDIENCE

USE WHATEVER THE AUDIENCE PREFERS

THAT SAID, WHILE IRR IS GREAT FOR GIANT MULTI-NATIONAL FIRMS, I PERSONALLY DON'T LIKE IT FOR

START-UPS

TO ME, IRR WORKS BEST WHEN COMPARING PROJECTS OF EQUAL

RISK OR EQUAL COST & INCOME REALIZATION

IT IS GREAT FOR A BIG FIRM TRYING TO COMPARE WHETHER TO BUILD A NEW DATA CENTER OF EXTEND THE

EXISTING ONE

BUT IMHO, IT IS NOT SO USEFUL AT COMPARING WHETHER TO INVEST IN A BIO-INFORMATICS START-UP OR A B2B

E-COMMERCE PORTAL, 2 PROJECTS WITH SIGNIFICANTLY DIFFERENT RISK

& SPEND PROFILES

THERE IS ONE LAST THING I WANT TO ADD

IN AN ACQUISITION SITUATION, RATHER THAN AN INVESTOR

SITUATION, HOPEFULLY THERE IS SYNERGY VALUE BETWEEN BUYER

AND SELLER

WHICH MEANS THAT PART OF THE VALUE OF THE DEAL IS NOT JUST

YOUR FUTURE REVENUE, BUT ALSO THE POSITIVE IMPACT ON THE

BUYER’S REVENUE AS A RESULT OF THE DEAL

WHETHER THIS CAN BE ADDED TO THE BASE VALUATION IS UP TO YOUR

NEGOTIATION SKILLS, BUT IMHO, IT SHOULD BE FACTORED IN TO BE FAIR

PART 3 YOU'RE WORTH WHAT THE

MARKET SAYS YOU'RE WORTH

THE FINAL METHOD OF VALUATION LEVERAGES THE WISDOM OF

CROWDS

SPECIFICALLY, YOUR VALUE SHOULD BE SIMILAR TO THE VALUE OF

SIMILAR FIRMS, IN SIMILAR INDUSTRIES, IN SIMILAR LIFE CYCLE

STAGES, AT THIS POINT IN TIME

BASICALLY, YOUR VALUE IS THE VALUE THAT THE INVISIBLE HAND OF

THE MARKET GIVES YOU

THE MOST COMMON WAY TO GUESTIMATE MARKET VALUE IS TO

LOOK AT COMPARABLES (SIMILAR-ISH COMPANIES TO YOURS)

AND SINCE NO COMPANY IS JUST LIKE YOURS, YOU NEED TO TAKE A BUNCH

OF DATA POINTS TO TRIANGULATE

THIS IS USUALLY DONE WITH P/E RATIO

ACTUALLY, YOU CAN SOMETIMES ALSO CONSIDER: PRICE TO BOOK RATIO, EQUITY / SALES, EQUITY / CASH FLOW, EQUITY / PAT, EQUITY / BOOK VALUE OF SHARE. BUT PE IS FAR

MORE COMMON FOR START-UPS

P/E STANDS FOR

PRICE / EARNINGS(THINK OF PRICE AS SYNONYMOUS WITH VALUATION

FOR THE MOMENT)

SO IF A FIRM’S VALUE IS 8 MILLION AND THEIR EARNINGS WERE 2

MILLION, THE P/E RATIO WOULD BE 4 SINCE

8 / 2 = 4

WE REFER TO THE VALUE OF 4 AS “THE MULTIPLE”

TO GET A VALUE FOR YOU, WE NEED TO USE THE AVERAGE MULTIPLE ACROSS ALL THE COMPARABLE

FIRMS WHO HAVE BEEN VALUED.

LET’S ASSUME FOR NOW, THAT THE AVERAGE MULTIPLE TURNED OUT TO

BE 4

WITH THE MULTIPLE AND YOUR PROFIT THIS YEAR, WE CAN REVERSE CALCULATE YOUR PRICE (VALUATION)

IF THE MULTIPLE IS 4AND YOUR PROFIT WAS 500K, THEN

YOUR VALUATION IS 2 MILLION

PRICE / EARNINGS = MULTIPLEPRICE = MULTIPLE X EARNINGS

2M = 4 X 500K

THIS MAGICAL MULTIPLE IS NOT AN ABSOLUTE NUMBER OF COURSE

THE P/E RATIO CAN CHANGE DRAMATICALLY FROM INDUSTRY TO

INDUSTRY AND IT CAN CHANGE IN THE SAME INDUSTRY OVER TIME

BECAUSE LIKE ANY WISDOM OF CROWDS, IT IS SENSITIVE TO MARKET

SENTIMENT

AND MARKET SENTIMENT IS FICKLE, IRRATIONAL, UNINFORMED, AND FULL

OF EMOTIONS

*(HEY CLASSICAL ECONOMICS…YOU CAN KISS MY A

DURING THE DOT.COM BUBBLE, I SAW TECH VALUATIONS OF 15X IN ASIA.

WHEREAS TODAY, TECH VALUATIONS ARE CLOSER TO 4X

THE VALUE OF THESE COMPANIES DID NOT CHANGE

WHAT CHANGED WAS THE HYPE SURROUNDING THE MARKET

SUMMARY

THANKS FOR READING. I TOLD YOU IT WASN’T ALL THAT HARD

HERE’S WHAT YOU NEED TO REMEMBER

THERE ARE 3 WAYS TO VALUE YOUR FIRM:

1. WHAT YOU OWN (USE ASSETS – LIABILITIES) – USED FOR LIQUIDATION

2. WHAT YOU’LL EARN IN THE FUTURE (USE NET PRESENT VALUE) – USED FOR INVESTMENT

3. WHAT THE MARKET SAYS (USE P/E RATIO) – USED FOR ACQUISITIONS

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