The Science and Art of Startup Valuations - Anjana Vivek

The Science and Art of Startup Valuations

TiE Masterclass BHive Workspaces, HSR Bengaluru

23rd August 2016Anjana Vivek

[email protected]

VentureBean Consulting Private Limited

Valuation: Questions ’to trigger thinking’

Valuation: Methods

Valuation: Process

Valuation: Focus Startup

Valuation: Summary

Agenda

2 2

VentureBean Consulting Private Limited 3

To trigger thinking…

ARE you

Building a Business or

Building Valuation


To trigger thinking…

• Can your company be the one that grows.. In business AND Valuation .. in the longer term

• What do you think of when you hear the word valuation for a business?

• What do you think it is related to?


To trigger thinking…Is valuation related to..

• Sales• Cost• Profit• Cash flow• Combination of above

• Other factors? What else?


• For Funding– Angel funding– Series A..X/Y– Strategic

• Funding cum– Incubation– Acceleration

• Other– Mentoring fee– ESOP plan

• Just because..

Why Valuation?


As a FOUNDERPut yourself in other party’s shoes…i.e. what is value to Buyer?

• Valued because of expected return on investment over some period of time; i.e. valued because of the future expectation

• Return may be in cash or in kind, tangible or intangible, or a combination of these

• Identify the drivers of valuation to Buyer



Valuation: Methods

Valuation: Process


Valuation: Summary

Agenda

8 8


Valuation methods

These can be broadly classified into:

• Cost based• Income based• Market based

For more details on the methods with examples please check the Appendix; spreadsheet illustrations will be shared on request


Some different ways to value

• Cost vs. Market Value

• Historical vs. Replacement

• Differs depending on need of person doing valuation – investor, entrepreneur, employee, advisor

• Depending on stage of business, whether for growth, super growth, exit, distress sale in times of downturn, closure



Valuation: Methods

Valuation: Process


Valuation: Summary

Agenda

11 11


ValuationBased on

• Tangibles and Intangibles

• Data and Assumptions

• Subjectivity and Objectivity

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Valuation

• At idea and early stage there is limited data, more subjectivity; higher weightage given to – Team – Potential market– Competitive scenario

• At next phase, more weightage is given to– Customer traction– Pipeline– Past record of conversion from pipeline etc.– Immediate past performance– Business and financial model

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Valuation• Many methods of computation are there, including but

not limited to– Multiples of revenue, EBIDTA, user base, etc– Multiples of industry specific value drivers, e.g. GMV (Gross

Merchandise Value), revenue per user, net margin per user– Cash flow based, discounted– Exit valuation expected

• These are again modified sometimes, for example revenue multiple may be an average of previous year, current year expected and forecast for year ahead; or it could be revenue multiple for one year ahead. The multiples will vary in both cases

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Valuation• Financial forecasts

• Are the starting point• Assumptions may be set out clearly• Look at different scenarios, optimistic, expected, pessimistic• Look at sensitivity to key parameters• Look at funded/bootstrap scenario and partial funding scenario• In focus in the due diligence review, prior to investment• Will factor in negotiations, so proceed with care when showing

this to an investor

• Statutory, accounting, tax implications to be factored in while arriving at valuation and deal cash flows

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ValuationDriven by:

• Markets: Flavor of season, competitive scenario, industry trends

• Team: At helm plus advisors/mentors/board• Cash burn: Or cash needed, look at scenarios

of minimum bootstrap and best case• Percentage sharing: Equity promoter is willing

to let go

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ValuationDriven by:

• Unbundling of deal issues, such as – Board Membership– Decision making powers– Payment/salary to founders– Assistance in administrative matters (eg. Incubation)– Contribution to execution and participation in key

activities such as sales, partner tie-ups– Liquidation preference– Exit clauses

• Negotiation and taking control of the situation17


Valuation

• Deals can sometimes be structured to accommodate valuation perceptions– For eg. linking to future performance – This could become an area of concern when there is

a possibility of a “down round” when new investors come into the picture

• For more on valuation: detailed class notes at http://www.slideshare.net/anjanavivek/valuation-basics (from set of the Top 4% & 5% viewed on SlideShare in earlier years)

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http://www.slideshare.net/anjanavivek/valuation-basics

http://www.slideshare.net/anjanavivek/valuation-basics


Process of valuation

• Identify current market models relevant to venture

• Justify methods selected, assumptions made

A valuation range is preferable to a single number


Process of valuation• Discount for risks, assign premiums • Look at expected value• Arrive at valuation range

– especially the point of walking away from the deal

• Identify deal issues (breaker/maker) for negotiation

• Practice before negotiating

A valuation range is preferable to a single number



Valuation: Methods

Valuation: Process


Valuation: Summary

Agenda

21 21


Valuation : StartupAt very early stage valuation is often a function of:

• Amount of cash burn (with different scenarios of bootstrap and adequate funding)

• Stake promoter is willing to give up

PLUS factors such as

• Value add expected from potential investor• Expected funds to be raised in future rounds, and

connecting this to future dilution expected to be made

It would help if you can articulate And

list this


Valuation: Startup to Exit.. To Think Thru


Valuation: Startup Examples – Incubation

Incubation by Tech company for idea stage venture:• Rs.50 lakhs was committed for 1st year, to be drawn on need

basis• Admin/accounting support to be provided • Co-working space provided• Mentors of centre available and assigned to venture for

periodic meetings• Domain experts from the pool of advisors to be connected to

founders• Monthly sustenance fee of Rs.20,000 per month agreed to for

each of 2 founders• 48% equity with Tech Company and balance held equally by

two founders• Forecast and valuation was connected to this and articulated


Valuation: Startup Examples – IncubationIncubation along with Acceleration for idea development:

• 3 member founding team was selected in a Batch for acceleration

• Mentors assigned from pool• 4 month program included sessions on idea development and

business planning for group as well as one-on-one special sessions with each group of promoters

• At end of period, the business idea and plan would be evaluated by a panel

• If approved, the founders would be incubated for a further period of 18-24 months, depending on requirement

• Initial seed funds of Rs.25 lakhs allotted, subject to review • Equity to be taken, varying between 8-15%, depending on

– Stage of readiness of business– Team experience– Requirement and other non-financial ask from incubator– Forecast and valuation calculated and articulated


Valuation: Startup Examples – IncubationIncubation for early stage company:

• Facilities and co-working space provided• Administration assistance provided• Mentors, CAs, lawyers and other professionals connected to

• Initial seed funds of upto Rs.25 lakhs available– Fund requirement to be evaluated– Funding in tranches, based on milestone– Utilisation to be reviewed

• Equity between 8-12%, depending on– Stage of company– Expected growth plan and projections– Dilution expected in future rounds of fund raising– Forecast and valuation calculated and articulated


Valuation: Startup ExamplesNames/data changed to maintain confidentiality..Service business: Value add measures:

• Two year co. – Rebranded, – Reclassified domain, pre-funding; – This was done on advise that revenue multiple would

go up from 3 to 5 • Three year co.

– Changed business model, increased outsourcing of some service delivery aspects.

– Cost of inputs increased, gross margins reduced– However operational efficiency increased, net profit

margins increased – valuation multiples; i.e. revenue and PBT multiples

increased by new potential investors


Valuation: Startup ExamplesNames/data changed to maintain confidentiality..

Investor negotiation:Early stage idea: • Jim had high technical knowledge, limited financial

knowledge.• Investor Z convinced Jim that he could partner and

grow the company to high value in 3 years and negotiated for half the business.

• Jim got into this without understanding how shares could get further diluted in later rounds of funding.

• At the end, Jim was left with less than 10% of the company he started, however valuation was high.


Valuation: Startup Examples – Mentoring Names/data changed to maintain confidentiality

Edtech Co. 1 year old:

• One face-to-face (FTF) meeting a month (half day i.e 3-4 hours)

• Advisory for growth strategy and mentoring of leadership team• 2% equity• by way of investment brought into the company at a small

premium• Forecast and valuation connected to this and articulated


Valuation: Startup Examples – Mentoring Names/data changed to maintain confidentiality..

Health tech idea stage: • Two meetings a month (2 hour), • Assistance in business model development• Funding strategy, in alternate scenarios of bootstrap and

funded, with assistance in fund raising• 5% equity • Equity investment brought in at par at the time of incorporation

of company• Forecast and valuation connected to this and articulated


Valuation: Startup Examples – Mentoring

• Range of equity sharing can vary

– from less than 1% to even 10%, depending on the experience, value add and brand value add by the mentor

– Sometimes can also include a cash component, for eg success fee as a % of funds raised % of revenue based on sales lead

• Forecast and valuation should be connected to this and articulated

• Statutory and tax issues MUST be addressed while equity is given


Valuation: Quality Factors.... To Think Thru

• FOCUS on Quality not just on Quantity …

• Illustrative parameter: Revenue Quality– Sales Quantity – Quality of revenue - in terms of product/service/vertical/location

etc.– Customer segments addressed– Average revenue per employee– Number of customers, number of high value customers– New customers added– Customers lost– Pipeline customers

• Customer acquisition strategy32


To trigger thinking …Investment in media/entertainment company: In the days when valuations were going through the roof…

(numbers changed to maintain confidentiality)

• HewS closed $10 million valuation from InvestorA• Reading press reports, Investor 2 wanted to participate and asked

the promoters to suggest a valuation• HewS Team and InvestorA decided at random: 20% increase in 1

week, leading to valuation of $12 million; • On flight as InvestorA travelled to meet Investor2, he decided he

would not just be a messenger, he would value add, so he decided to up valuation to $18 m

• During negotiations, Investor2 gave final offer of $15 m• Thus in about 10 days the company valuation went up by 50%, from

$10 m to $15 m• Founders ended up with more money than they had planned for and

had to think of ways to spend this!

TODAY the story is reversed.. Valuations are dropping/fluctuating


To trigger thinking …Ref: Economic Times: Feb 29, 2016: Flipkart’s valuation markdown: Billions gone in a flash

ReadMore@:http://economictimes.indiatimes.com/articleshow/51182907.cms?from=mdr&utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

http://economictimes.indiatimes.com/articleshow/51182907.cms?from=mdr&utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst





Valuation: Methods

Valuation: Process


Valuation: Summary

Agenda

35 35


Valuation• Identify valuation methods and drivers in your

industry

– Number of customers?– Revenue?– GMV?– Number of unique views?– Average revenue per customer?– Profitability?– Cash Flow generated?– Combination of above?– Other?

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Valuation

• Identify what could be

– Value drivers – Value depleters

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Valuation

• At the start value is mostly intangible, look at how this can be made tangible..

• For eg. service – through content, follow up calls, showcasing feedback, etc.

• Can you think of how you can demo value in early days of your business

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ValuationSome examples of value demonstrated:

• Association with credible organisations (incubation, acceleration etc..)

• Team: Reputed/trustworthy; experienced/multi-disciplinary

• Marquee/discerning customers

• Other stakeholders associated – Advisors, investors, bankers, well known professional service firms etc.

• Feedback/testimonials from reputed persons

• Ability to charge premium pricing

• Ability to address a huge market – i.e. ecommerce companies, value without profits

For more: 5 Points on Valuation and Negotiations… OR … how You can get a better price

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https://www.linkedin.com/pulse/20140630153355-2098566-5-points-on-valuation-and-negotiations-or-how-you-can-get-a-better-price?trk=mp-reader-card

https://www.linkedin.com/pulse/20140630153355-2098566-5-points-on-valuation-and-negotiations-or-how-you-can-get-a-better-price?trk=mp-reader-card


In Summary• Build a Financial Model that is consistent, capture

elements of business model; address deal rationale

• Look at different valuation models; arrive at a value range

• Prepare for negotiation– Identify deal issues– Think through possible negotiation strategies– Check that your house is in order for due diligence, else

you may provide hooks for pulling down your valuation

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In SummaryCaution

• Look out for concern issues, hidden agendas; evaluate on value-based parameters including but not limited to fund source, governance, ethics and reputation

• Keep an eye on the law and statutory regulations; these also impact valuation and deal negotiation

• Plan for advisors/CAs/lawyers, due diligence costs and other deal related costs which will add to the price paid or reduce the price received for any transaction

• Plan for long term impact of decisions on valuation

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Thank you

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Reference:

For teaching notes, articles and more on finance, valuation, business models, leadership and more..

• www.slideshare.net/anjanavivek (Global TOP 4%/5% for 2 years)• https://www.linkedin.com/today/author/anjanavivek?trk=prof-sm • https://

www.linkedin.com/pulse/venture-a-question-start-up-valuation-anjana-vivek?trk=mp-reader-card

• https://twitter.com/VentureBean• http://

www.linkedin.com/company/venturebean-consulting-private-limited

• https://www.facebook.com/pages/VentureBean-Consulting-Private-Limited/387846908091034

http://www.slideshare.net/anjanavivek

https://www.linkedin.com/today/author/anjanavivek?trk=prof-sm

https://www.linkedin.com/pulse/venture-a-question-start-up-valuation-anjana-vivek?trk=mp-reader-card



https://twitter.com/VentureBean



http://www.linkedin.com/company/venturebean-consulting-private-limited




https://www.facebook.com/pages/VentureBean-Consulting-Private-Limited/387846908091034




More on Valuation Methods

APPENDIX


Valuation methods

Broadly classified into:• Cost based• Income based• Market based

• Different experts have different classifications of the various methods of valuation

• Within these methods, there are sub-methods• Sometimes the methods overlap


Cost based methodsThere are different ways of arriving at cost:

• Book value

• Replacement value

• Liquidation value

NOTE: These methods could become relevant – In times of valuation downrounds; to get salvageable value– when one is considering the accounting, legal and tax impacts of

valuation, for eg.• in deals related to M&As, JVs and partnerships etc..• in cross-border transactions, depending on countries involved


Income Based methods

• Earnings capitalisation method or profit earning capacity value method

• Discounted cash flow method (DCF)


INCOME: Earnings capitalisation method

• Also known as Profit earnings capacity value (PECV)

• Value determined by capitalising earnings at a rate considered suitable

• Assumed that the underlying value driver of the company is its future earnings potential

• Suitable for fairly established business having predictable revenue and cost models

• For example – assume that Company Profittee Limited is earning post

tax profit of Rs. 5 crores and we would like to capitalize this at 10%.

– The value of the Profittee Limited under this method is equal to Rs. (5/10%) crores, ie Rs. 50 crores.


nt

tt

t

rCFValue

1 )1(• CF = cash flow • t = the year and • r = discount rate

i.e. the cash flow for each year from year 1 to year n (which is the timeperiod under consideration) is discounted to arrive at the present valueof future cash flows from year 1 to n

INCOME: Discounted cash flow


• Based on expected cash flow & discount rates• Quality of valuation is dependent on the

assumptions behind the forecast• Sometimes it is difficult to get a reliable

estimate for the future and the valuation model may need modification, for example as below:

INCOME: Discounted cash flow

Value: Phase 1

Discounted Value: Phase 2

Terminal Value

Figure: Net present value

NPV of Enterprise

D isc o u n te d

D isc o u n te d


Market based method

• Also known as relative method• Assumption is that other firms in industry are

comparable to firm being valued• Standard parameters used like multiples of

revenue, EBIDTA, PAT, book value, • Other indicative parameters such as revenue,

revenue per user, net margin per user etc.• Adjustments made for variances from standard

firms or deals in the recent past, these can be negative or positive; i.e. premiums and discounts are assigned


Exercise in Valuation - I

Plantation Co. Garden Co. Park Co.Enterprise value/sales 1.4 1.1 1.1Enterprise value/EBITDA 17.0 15.0 19.0Enterprise value/free cash flows 20 26 26

Meadows Co.Sales Rs. 200 croresEBIDTA Rs. 14 croresFree cash flow Rs. 10 crores

How would you value Meadows Co. based on the market/industry information provided?


Plantation Co. Garden Co. Park Co. AverageEnterprise value/sales 1.4 1.1 1.1 1.2Enterprise value/EBITDA 17.0 15.0 19.0 17.0Enterprise value/free cash flows 20.0 26.0 26.0 24.0

Application to Meadows Co. Average ValueSales Rs. 200 crores 1.2 Rs. 240 croresEBIDTA Rs. 14 crores 17.0 Rs. 238 croresFree cash flow Rs. 10 crores 24.0 Rs. 240 crores

Exercise in Valuation – I: Possible Solution


Papers Co Docs Co. Prints Co.Enterprise value/sales 2.6 1.9 0.9Enterprise value/EBITDA 10.0 21.0 4.0Enterprise value/free cash flows 21.0 30.0 24.0

Application to PenPencil Co.Sales Rs. 300 croresEBIDTA Rs. 15 croresFree cash flow Rs. 7.5 crores

Exercise in Valuation - II

How would you value PenPencil Co. based on the market/industry information provided?


Papers Co Docs Co. Prints Co. AverageEnterprise value/sales 2.6 1.9 0.9 1.8Enterprise value/EBITDA 10.0 21.0 4.0 11.7Enterprise value/free cash flows 21.0 30.0 24.0 25.0

Application to PenPencil Co. Average ValueSales Rs. 300 crores 1.8 Rs. 540 croresEBIDTA Rs. 15 crores 11.7 Rs. 175.5 croresFree cash flow Rs. 7.5 crores 25.0 Rs. 187.5 crores

As there is a wide value range, the application of the relative multiples does not look appropriate in this case. What are your thoughts on this?

Exercise in Valuation – II: Possible Solution


• Simple and easy to use• Useful when data of comparable firms and assets are

available• Useful when information about recent deals are available

Limitations• Difficulty in getting data, particularly for unlisted companies• Easy to misuse• Selection of comparable can be subjective• Errors in comparable firms get factored into valuation model

Market based method

The Science and Art of Startup Valuations - Anjana Vivek

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