FInancial Modeling and Valuations for Startups: Telling your Story with Numbers

TELLING YOUR STORY WITH

NUMBERS Efrat Kasznik, Founder & President Foresight Valuation Group, LLC

October 14, 2014 San Diego, CA

FINANCIAL MODELING AND VALUATIONS FOR

STARTUPS:

Foresight Valuation Group © 2014

“Are Accountants and CFOs Killing Innovation?”

-- New Knowledge Online Magazine,

INSEAD, March 7, 2013

3 Foresight Valuation Group © 2014

About Me: Efrat Kasznik

¨  Founder and President, Foresight Valuation Group, a Silicon-Valley based Intellectual property (IP) valuation, strategy and start-up advisory firm.

¨  Valuation and strategy expert, with 20 years of experience analyzing IP and technologies across industries

¨  Lecturer, Stanford Graduate School of Business

¨  Chair, Cloud Committee, Licensing Executives Society (LES)

¨  Top IP strategists, IAM 300 List 2013-2014

¨  Co-founder, CFO and Advisor to startups and incubators in the US and Europe, including: Stanford Venture Lab, The HUB Trieste, Astia Angel Fund


Guess the Company?


The Valuation-Information Timeline

Seed Funding Series A Series B…

M&A

IPO

Available Information

Low High


Outline

¨ The Funding Cycle

¨ Building a Financial Model using CURVE TM

¨ The Startup Valuation Puzzle


The Funding Cycle


Sources of Cash

$

Equity

Debt

Revenues


Sources of Cash: Equity

Types Who? Return Pros Cons

•  Common Stock

•  Preferred Stock

•  Private investors (Angels)

•  Institutional investors (VCs)

•  Public investors (IPO)

•  Price Appreciation

•  Dividends

•  Long term payback

•  No drag on ST cash flow

•  No collaterals

•  Not Taxable

•  Ownership dilution

•  Regulatory and reporting compliance

•  Liquidity, voting preferences (preferred stock)


Sources of Cash: Debt


•  Loans •  Line of credit) •  Convertible

Notes (hybrid)

•  Financial Institutions (Banks)

•  States, Cities •  Public (bonds)

•  Periodic Interest

•  Repayment of Principal

•  Collateral (in case of default)

•  No ownership dilution

•  No preferential voting rights

•  Not taxable •  Interest is tax

deductible

•  Short term payback (usually)

•  Burden on monthly cash flows

•  Lien on assets (collateral)

•  Available to revenue-producing companies

•  Extensive disclosure to lenders


Sources of Cash: Revenues


•  Sales of Products & Services

•  Subscriptions •  Licensing •  Advertising •  Sponsorships

•  Customers •  Partners •  Channels •  Brands

•  Tangible: products or services

•  Maintenance •  Upgrades •  User

community

•  No ownership dilution

•  No preferential voting rights

•  Access to user/consumer data

•  Fulfillment liability

•  Taxable income


The Equity Funding “Triangle”: The Right Funding at The Right Time

Funds Raised ($)

Ownership (%)

Pre-Money Valuation

($)

< $1M

33% $2M


Less than 1% of New Businesses are Venture Funded

Source: The Kauffmann Firm Survey, March 2008


Total VC Investments: 2010 to Date


VC-backed Exits: 2010 to Date


Building a Financial Model


Startup Financial Management

¨  Cash management ¨  Accounting/Taxes ¨  Financial planning/budgeting ¨  Fundraising


Cash Management

¨  Startups often focused on short-term cash management

¨  Don’t lose sight of big picture! ¤ Bootstrapping is not a financial strategy ¤ Don’t make compromises that hurt your long term goals ¤ Goal should always be increasing value of company


The CURVE TM Financial Model

COST

USERS

REVENUES

VALUATION for ENTREPRENEURS


Goals for Financial Modeling

¨  Manage Investor Expectations ü  True for all companies, from startups to public co’s

¨  Set Foundation for Valuation ü  Understand valuation trajectory over time

¨  Create an Operating Budget: ü  Evaluate funding needs & funding sources ü  Prioritize spending to optimize return on investment


Financial Model Flow: Telling Your Story with Numbers

User/Customer/Unit

Rollout:

Model Infrastructure

Revenue Buildup:

Return on Investment/Valuation

Cost Buildup:

Basis for fundraising


The User Base is the infrastructure on which the financial model is built:

q  Choose a modeling unit q  Roll out users based on:

u  Go-to-Market plan u  Product/engineering roadmap

q  Benchmark results against target market to estimate penetration

1. User/Customer/Unit Rollout


User Rollout Example: Content Aggregator Mobile App

Modeling Unit Definition: User Account


User Rollout Trajectory: Mobile Apps Build from the Bottom UP

User rollout trajectory is

modeled by Time To A Million

downloads, based on other popular

applications


User Rollout Example: Five Year Forecast Results

Year 1 •  0.6 million





Company accounts at end of year

-‐

2

4

6

8

10

12

14

16

18

20

0 5 10 15 20 25 30 35 40 45 50 55 60 Do

wnloa

ds (M

illions)

Months From Launch

Company Accounts

Total Batzu Accounts (MM) Total Company Accounts (MM)


Benchmarking Your Results

1.  Compare “Apples to Apples” when showing market penetration

¤ Choose the right market for the calculation 2.  Make Sure you are “In the Range”

¤ And if not in the range you need a very good explanation why you are an outlier!

3.  Standardize your comparison units: ¤ Per User ¤ Per Employee ¤ Per Unit


User Benchmarking: Top Down Penetration

-‐

50.00

100.00

150.00

200.00

250.00

300.00

Jan-‐13

Apr-‐13

Jul-‐1

3

Oct-‐13

Jan-‐14

Apr-‐14

Jul-‐1

4

Oct-‐14

Jan-‐15

Apr-‐15

Jul-‐1

5

Oct-‐15

Jan-‐16

Apr-‐16

Jul-‐1

6

Oct-‐16

Jan-‐17

Apr-‐17

Jul-‐1

7

Oct-‐17

Millions

Internet Users in La?n America (MM)

Hispanic ownership of mobile devices, US & Mexico (MM)

Total Batzu Accounts (MM)

28

Total Company Accounts (MM)


Revenues represent the opportunity for investors, and the basis of valuation for early stage ventures

q  Identify all monetization opportunities q  Focus on top 2-3 revenue sources at the most! q  Project revenues at least 3 years out (5 if possible) q  Benchmark results against comparable companies

2. Revenue Buildup


Sources of Revenues

¨  Product sales ¨  Services ¨  Subscriptions ¨  Licensing/Revenue Share ¨  Advertising ¨  Sponsorships ¨  Data mining


Sources of Revenue Example: Mobile Apps

Advertising

Freemium account Upgrades


Advertising Example: A User Session

Log In Select Story Consume Content Select Channel

Opportunity for ad impression

We have assumed that the average account holder will use app about 2 times per week

Opportunity for ad impression


Advertising Revenue Unit: cost per mille (CPM)

¨  The cost of an online advertising campaigns is determined by the total number of impressions (= pages that users see)

¨  The impressions are sold as advertising space in units of 1,000 (mille) display ad impressions

¨  The rate quoted for impressions is the cost per mille, abbreviated as CPM ¤ CPM = the cost for 1,000 display ad impressions


Premium Subscription Example: Revenue Assumptions

¨  Upgraded account allows access to additional premium content and other premium features ¤ $2 monthly subscription price for premium accounts ¤ 3% of users become premium subscribers ¤ Cost of premium content is 20% of the upgrade

subscription ¤ Premium accounts will be offered starting in Year 2


- - 2.9

6.0 9.9

0.5 3.1

9.9

21.5

37.2

0.5 1.0

1.5

2.0

2.5

-

10.0

20.0

30.0

40.0

50.0

60.0

Year1 Year2 Year3 Year4 Year5

Reve

nue

($M

M)

Gross Premium Account Revenue ($MM), Global Interstital Ad Revenue per Month ($MM) Branded content channel revenue ($MM), Global

Revenue by Source: Five Year Forecast Example

35

$14.3MM

$29.5MM

$49.6MM

$4.1MM $1.0MM


$2.96 *$3.61 $4.84

$7.04 $7.50

$9.56

$28.56

$-

$5.00

$10.00

$15.00

$20.00

$25.00

$30.00

Twitter Batzu Facebook LinkedIn Pandora AOL Google

Average Annual Revenue per User: Benchmark Analysis

36

*$49.55 million gross revenue in year 5 / 13.74 million average Batzu accounts in year 5 = $3.61 average annual revenue per user

Company


Expenses represent the basis for fundraising : q  Direct Cost >> vary with revenues (COGS) q  Fixed Cost >> mostly payroll (org chart) q  Other fixed cost: IT, office expenses, marketing,

licensing, legal, professional fees q  Benchmark Cost against expenses, industry ratios

3. Expense Buildup


Principals of Cost Planning

¨  Minimize the overhead (and inventory), and make cost as variable as possible, so you only pay when you make money

¨  Funding the overhead, and your working capital gaps, so you don’t dilute your shareholders


Cost Modeling Overview

Cost Function: •  Cost of Goods Sold •  Engineering •  Sales and

Marketing •  General and

Administrative

Years 1 & 2 are predicted on a monthly “burn

rate” basis based on actual

assumptions

Years 3 – 5 are driven as a

percentage of revenue using

industry normalized

ratios


CEO

CMO

Director of Marketing and

PR

Marketing manager

PR manager

PR manager

Director of Sales and Business Development

Director of New Business Ventures

Business Development

Manager

Business Development

Manager

Sales Representative

Sales Representative

Chief Content Officer

Country Publisher (Mexico)

Director of Branded Content

Creation

Copywriter

Copywriter

Copywriter

Copywriter

Copywriter

Director of Content Curation

Content Curator

Content Curator

Content Curator

Director of Page Design

Page Designer

Page Designer

Country Publisher (U.S.)

COO

Controller Various Consultants

Legal Services

CTO

Project Manager

Dev Leader

Backend Dev

Backend Dev

HTML5 Dev

HTML5 Dev

Mobile Dev)

Mobile Dev)

Graphic Designer QA Analyst

QA Analyst

System Admin

Director of Operations

To be Hired Immediately

To be Hired in Year 2

To be Hired in Year 3

Sitting in Mexico Office Outsourced

Marketing Sales & Business Development

Engineering Publishing

Administrative

Payroll – Organizational Chart

Key:


Communicating With Investors


Investor Communications: Top 5 Best Practices

1.  Don’t send Excel without “Voiceover” presentation 2.  Clearly lay out key metrics on a Dashboard 3.  Use Graphics as much as possible 4.  Know your numbers inside and out!

¤ Know the micro (user level profitability) ¤ Know the macro (financial projections)

5.  Know your investor’s goals and objectives and plan your message accordingly


Investor Communications: Financial Model Dashboard


Investor Communications: User Engagement Metrics (SaaS)


Income Projections: Five Year Forecast

45

User Base Summary (millions) Year 1 Year 2 Year 3 Year 4 Year 5Batzu Accounts at End of Year 0.6 2.1 5.8 10.4 16.4 Average Yearly Accounts 0.2 1.3 4.0 8.4 13.7

Batzu Financial Summary ($ Millions) Year1 Year2 Year3 Year4 Year5RevenueInterstital Ad Revenue per Month 0.5 3.1 9.9 21.5 37.2 Gross Premium Account Revenue -‐ -‐ 2.9 6.0 9.9 Branded content channel revenue 0.5 1.0 1.5 2.0 2.5 Gross Revenue 1.0 4.1 14.3 29.5 49.6

Cost of advertising 0.1 0.9 3.0 6.4 11.1 Cost of Premium Revenue -‐ -‐ 0.6 1.2 2.0 Net Revenue 0.8 3.2 10.7 21.9 36.4

CostsResearch & Development 1.3 1.3 2.1 4.4 7.4 Sales & Marketing 1.0 2.7 5.0 7.4 9.9 Content Publishing 1.5 1.5 1.7 3.5 5.9 General & Administrative 1.1 1.1 1.4 3.0 5.0 Total Operating Costs 4.9 6.6 10.3 18.3 28.2

EBITDA (4.1) (3.4) 0.5 3.6 8.2


Revenue vs. Cost: Five Year Forecast Aggregation

1.0 4.1

14.3

29.5

49.6

4.9 6.6

10.3

18.3

28.2

-

10.0

20.0

30.0

40.0

50.0

60.0

Year1 Year2 Year3 Year4 Year5

Dol

lars

($M

M)

Gross Revenue Total Operating Costs

Breakeven Point


The Startup Valuation Puzzle


What’s in a Billion Dollars?


High Valuations for Pre-Revenue Startups

Raised $225M at $3.8B Valuation (Oct 2013)

$338M raised to date 70M active users $0 Revenues

Raised $50M at ~$2B Valuation (Dec 2013)

$123M raised to date 60M installs, 30M active users monthly 16.5M users and 350M photos shared daily $0 Revenues


Key Performance Indicators (KPI): The New Valuation Fundamentals

KPI = Measurable Indicators of Scalability & Execution

¤  User Engagement - active users ¤  # of Installs ¤  Customer Acquisition Cost (CAC) ¤  Customer Lifetime Value (LTV) ¤  Average Revenue Per User (ARPU) ¤  Customer Attrition (Churn Rate) ¤  Conversion Rate (funnel)


The “Billion Dollar” Club (Source: WSJ)


Startup Valuations: The Market Perspective

More Exits

In 2013

User Engagement

High Growth

Industries

More Funding Options

•  Angels •  VCs •  Private Equity •  Crowdfunding

•  230 IPOs; $55B US •  10k M&As deals; $100B US •  Active Secondary Market

•  Healthcare •  Internet of Things •  Social Media

$3.2B Valuation

Nest Labs

•  # Active Users •  # Installs/Subscriptions •  Conversion Rate •  Churn Rate


Startup Valuations: The Investor Perspective

Industry Benchmarks

Company

Metrics

Investment Objectives

External Factors

•  Long Term Growth

•  Ecosystem: partnership, channels

•  Regulation •  Litigation

•  Competitors •  Valuation Comps •  Funding & Exits

•  Target ROI •  Exit Horizon •  Portfolio Companies

•  Team •  Product •  Execution (Beta) •  Intellectual property


Early Stage Valuation Methods

¨  VC Valuation Approach

¨  Comparable Valuation Approach

¨  Heuristic Approaches (experience based) ¤ Example - Dave McClure’s 5 Points


$20 Million

$100 Million

$5

Million

$2.5 Million

5X Exit Multiple

70-80% Discount Rate

= 20x ROI

Revenue in Year 5

Value in Year 5

VC Valuation Approach: At Exit Point (Year 5)

Value Today

50% future dilution

Fully Diluted Value Today


VC Valuation Approach: Sample Revenue Multiples (2012)

56


VC Valuation Approach: Industry Standard Discount Rates

•  80%+ Seed

•  50-70% Angel

•  40-60% Series A

•  30-50% Series B

•  25-35% Bridge

Sources: How Venture Capital Works , Harvard Business Review A Method for Valuing High-Risk Long-Term Investments, Harvard Business School


Comparables Valuation Approach: Pre-Money Valuation Range

Source: Halo Report 2013


Heuristic Approach: The Dave McClure Five “Million Dollar Points” *

¨  Discussed in Q&A by Dave McClure (500 Startups) at a TechCrunch Disrupt Event (2011)

¨  Each “point” worth $1M: 1.  Market 2.  Product 3.  Team 4.  Customers 5.  Revenue

>> Maximum: $5 Million ¨  * Efrat’s 6th point: IP (patents)>> add another $1M


The Startup Valuation Spectrum


Startup Valuation Resources

¨  Angel Resource Institute www.angelresourceinstitute.org

¨  Fenwick & WestSeed Financing Survey 2012 of Internet/Digital Media and Software Industries

¨  Silicon Valley Bank: The HALO Report 2013

¨  The Kauffman Foundation: Valuing Pre-Revenue Companies ¨  Center for Venture Research https://paulcollege.unh.edu/cvr

THANK YOU!

Efrat Kasznik President, Foresight Valuation Group

[email protected] www.linkedin.com/in/ekasznik

Office: 650-561-3374

www.foresightvaluation.com

Presentation available upon request

FInancial Modeling and Valuations for Startups: Telling your Story with Numbers

Small Business & Entrepreneurship

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