Valua%on of University Startups

PanelDiscussionwith:• Moderator:BobHisrich,PhD,KentStateUniversity

• HelenaWisniewski,PhD,UniversityofAlaska,Anchorage

• GaryGibbons,PhDThunderbirdSchoolofGlobalManagement

• SteveRoberts,KentStateUniversityDirector,TechnologyCommercializaHon

Valuing University Startup Companies

•  ThreeacceptedvaluaHonmethods-

•  MarketApproach.LookatsimilartransacHonsinopenmarkets.

•  CostApproach.DeterminethevaluebycalculaHngtheamountofmoneyrequiredtorecreatetheproperty.

•  IncomeApproach.Howmuchincomecanthiscompanygenerateoverthelifeofthecompany?

Intheory,thisisfarandawaythebestmethod.

Valuing Startup Companies- Pre-Revenue

• It’sHard!

Valuing Startup Companies- The Balance Sheet

•  BalanceSheet•  Assets-

•  LicenseoropHontolicenseuniversitytechnology(usuallyuntestedtechnology)•  SmartpeoplewithaStory(probablythesourceofanyrealvalue)•  Friendsandfamily•  Somelocaloruniversityentrepreneurialecosystem

•  LiabiliHes-•  LiUleornocashoraccesstocapital•  LiUleornomanagementexperience•  Limitedunderstandingofthemarket•  Regulatoryhurdles•  Lotsofmouthstofeed•  AngryandaggressivecompeHtors

Valuing Startup Companies- Beware of Hockey S%cks

Spendinga$1forEvery$1ofRevenue-Notarecipeforsuccess

Valuing Startup Companies- Why it is important to get the value correct •  Iftheseed-stagevaluaHonistoohigh…

•  ThefinancialcontribuHonisundervaluedandtooliUlestockreceivedbyinvestors•  Easierforsmartmoneytowalkaway•  SeedroundsHmingcanbesignificantlyextendedandahigherlikelihoodofadownroundlater•  Problemsifthecompanymissesanimportantmilestone

•  Iftheseed-stagevaluaHonistoolow…•  EntrepreneursarelessmoHvated•  IncreaseddiluHona]ermulHpleroundsoffunding

Valuing Pre-Revenue Startup Companies- 3 handy methods • VentureCapitalMethod

•  ScorecardMethod

• BerkusMethod

Valuing Startup Companies- Venture Capital Method • Post-moneyValuaHon=TerminalValue÷AnHcipatedROI

•  Where-TerminalValueisanHcipatedsellingpriceofthecompanyin5to8years•  AnHcipatedROI10to30X

•  Example-companyneeds$1millioncashandexpectedtosellfor$50million.Investorsdemand20%ROI

$50,000,00020=$2,500,000.Less$1millioninvestment=$1.5millionPre-money valuaHon.

Valuing Startup Companies- Scorecard Method

Criteria Weigh*ng ComparisonAdjustedWeigh*ngEntrepreneur,Team,Board 30% SizeofOpportunity 25% Product/Technology 15% Compe**veEnvironment 10% Sales/Marke*ng 10% NeedforMoreFinancing 5% Other 5%

Valua%on of Startup Companies- Berkus Method

Fora“perfect”idea,possibilityof$2to$2.5millionpre-moneyenterprisevaluaHon

Valua&onofEarlyStageStartups–ArtorScience?

Dr.HelenaS.WisniewskiViceProvostforResearch&GraduateStudies

UniversityofAlaskaAnchorage

v Ihavehearditsaidthat:Businessvalua+onismoreartthanscience.Ifthisistrue,thenstartupvalua1onisindomainofthear1st.

v Buttheissueisthatyouneedtoputavalueofyourstartuptoraisemoney,andinvestorsneedtoputvalueontheirinvestmentstogenerateliquidity.

v Ifyouhavesoldahouseyouknowthatyoutakecertainfactorsintoaccount:loca1on,salesofcomparablehousesinyourarea,upgradesetc.,butintheenditisworthwhatsomeonewillpayforit.

•  Similarforvalua1onofstartups,inpar1cular,earlystagepre-moneyvalua1ons.

v Therearepercep1onsandgeneralrulesofthumbandsomemethodsthatIwillshare.Theseincludepercep1onsbasedonmyexperiencesfromastartuppointofview,andfromexperienceswithinvestorsfromtheirpointofview-andwheredotheyconverge?

ArtorScience?

v  WhenIformedmyfirststartupinbiometrics,Isoughtguidancefromaco-founderoftheTitanCorp.,whomIhadworkedfor.

v  Hetoldmesomegeneralrulestodeterminevalua1onthatwerepointsthatinvestors

willconsiderwhendecidingtoinvestornotthatincluded:•  IPporGolio.•  Prototypedeveloped.•  Customers–orleIersofsupportthatsaytheywillbuyitonceproductisavailable.•  Needfortheproduct–nicetohaveormusthave.•  Financialprojec1ons–marketsize.

•  Howlongbeforeitisprofitable.•  Breakevenpoint.

•  Exitstrategy.•  StrongManagementteam.

v  Alsodoacapitaliza&ontabletodeterminehowmuchyouneednowtogettonextlevel,ifyouwillneedmoremoneybeyondtheseedlevel,andhowmuchdoyouwanttoendupwithasthefounder.

BythewayIconvincedhimthatIhadthesepoints,weagreedona$2Mvalua=on,andhebecamemyfirstinvestor.IthenusedthemforstartupsIformedatStevensandUAA.

SomeGeneralRulesofThumb

TheDavidBerkusMethodIfExists:

AddtoCompanyValue

upto:SoundIdea(basicvalue) $1/2million

Prototype(reducingtechnologyrisk) $1/2million

QualityManagementTeam(reducingexecu1onrisk) $1/2million

Strategicrela1onships(reducingmarketrisk) $1/2million

ProductRolloutorSales(reducingproduc1onrisk) $1/2million

Total:$1.5M

v Thereisnoperfectmethodology,althoughsomepopularmethodsusedbyangelinvestorsandVCsare:•  DaveBerkusmethod.•  ScoreCardmethod.•  RiskFactormethod.•  VCmethod.

NoPerfectMethodology

v  ScoreCardMethod–usescomparables-needtounderstandhowmuchsimilarcompaniesinyourindustry/geographyareworth.

•  Thefirststep:determinetheaveragepre-moneyvalua1onofthepre-

revenuecompaniesinyourregionandbusinesssectorofyourcompany.Varieswiththeeconomyandthecompe11veenvironmentforstartupventureswithinaregion.

•  Thenextstepistocompareyourcompanytoyourpercep1onofsimilardealsdoneinyourregion,consideringthefollowingfactors:

o  StrengthoftheManagementTeam 0–30%o  SizeoftheOpportunity 0–25%o  Product/Technology 0–15%o  Compe11veEnvironment 0–10%o  Marke1ng/SalesChannels/Partnerships 0–10%o  NeedforAddi1onalInvestment 0–5%o  Other 0–5%

ScoreCardMethod

v Whatcanyouexpectinthesizeofinvestment?

•  Onaverageearlyseedaround$1Mto$5M.•  However,ifyoudonothaveallthenecessaryvalida1onelements,butthe

investorlikeswhatyoudohave,theninvestormightprovide$50-100Ktoprovevalida1on–theyget20%withrightoffirstrefusaltoprovidenexttrancheoffunding.

v Sohowmuchdoyougiveup?•  %variesbycase,butonaveragepremoneyinvestorcaptures15%to20%.v Alsonotethat:

•  Agoodmanagementteamismorevaluedthanagoodtechnology.

HowMuchCanyouExpect?

v  Supposethatyouhaveabigideabutdon’tknowhowbig,thenconsidera

SAFEnote-“simpleagreementforfutureequity”–unlikeaconver1blenoteitisnotdebt.

•  ASAFEisanagreementbetweenacompanyandaninvestor.•  Inexchangeforthemoney,theinvestorreceivestherighttopurchase

stockinafutureequityround(whenoneoccurs)subjecttocertainparameterssetinadvanceintheSAFE.

•  Ididonerecentlyforastartup.

v  AReferencestoorganizeyourvalida&onthoughts:•  Altainnova&on.com–BigIdeaAnaly&csgivesa5stepmethodtoassessnewideasbyansweringcri1calques1onsupfrontforanewtechnology.Processhelpsyouunderstandifyourtechnologyhaswhat'sneededtoraiseventurecapital.

Alterna&veMethod

•  Yourcompanyisworthwhatsomeonewill

paytoinvestinit,anditisuptoyoutoconvincethemitisworthwhatyouareasking.

•  Youcanusetheseorsimilartoolstoconvincethem.

FinalThoughts

Problems Encountered When Valuing Entrepreneurial Firms

CopyrightDr.GaryGibbons2017

Informa;on

• Risk•  Knowable•  Abletoes=mate•  Measuredsta=s=callyorwithexpertknowledge

• Uncertainty•  Unknowable•  Cannotbemeasuredsta=s=callyorwithexpertknowledge

CopyrightDr.GaryGibbons2017

Lack of Cash Flow Now or in the Near Future

•  Expertopinion• Conjointanalysis• Problemisindustryspecific

CopyrightDr.GaryGibbons2017

Basic Valua;on Hypothesis

•  Thevalueofanyassetisequaltothevalueofallfuturebenefitsdiscountedbacktotodayattheappropriateriskadjustedrateofreturn.•  Theproblemsare:

• Whatarethefuturebenefits• Whatistheappropriateriskadjustedrateofreturn

CopyrightDr.GaryGibbons2017

Graphically this Problem is Expressed:

CopyrightDr.GaryGibbons2017

TerminalValue

ValueToday

I=RRRi=periodicrrr

Perio

dic

CashFlow

N=NumberofYearsn=numberofperiods

Whatarethefuturebenefits?

Whatistheappropriateriskadjustedrateofreturn(RRR)?

Problems with Future Benefit Flows

• Whatarefuturebenefitflows?• Whatformorshapedotheytake?• Howlongdotheycon=nue?• Aretheygrowingordeclining• Dothey“workthewaythefirmworks?”

CopyrightDr.GaryGibbons2017

Problems with Appropriate Risk Adjusted Rate of Return: Type I - Where Heuris;cs and/or Rela;ve Measurements are used •  P/E

•  P/B•  P/S•  XEBITDA

•  Easytouse(maybeappliedtonextcashflowortoasinglevalue)•  Thesearegeneralnotfirmspecifices=mates;Theyarebasedongeneralcondi=onssubjecttochangeandinaccuracy•  Theydonotexpressanyuniqueaspectsregardingthetargetfirm;theydonot“workthewaythefirmworks”

CopyrightDr.GaryGibbons2017

Problems with Appropriate Risk Adjusted Rate of Return: Type II- Where Computed Risk Premiums like MCC and WACC are used

•  Costofdebt•  Costofpreferredstock•  Costofequity

•  CAPM/Fama-French•  GordonGrowth•  Build-up•  Manyothers

•  Thesemethodsabempttodeterminea“firmspecific”requiredrateofreturn(RRR)•  Thesemethodsassumeasta=ccapitalstructureandunchangingyieldcurve

CopyrightDr.GaryGibbons2017

Problems with firm specific opportunity assessment where cash flow is not yet present

• Comparablefirmanalysis•  Useaqualita=vescoringmethodologythatisconsistentfromfirmtofirm•  Bestprocedureisto:

•  Problem/marketandcompe==on•  Productposi=oninmarket(andintrinsicvalue)•  Businessmodel(cantheentrepreneurmakeandsellatagrossprofit)•  Managementteam•  Financialneeds,projec=onsandinvestmentstructure

CopyrightDr.GaryGibbons2017