Valuation models for early-stage technology companies

19
Valuing Early-Stage, Knowledge-based/Tech Companies November 22, 2013 Gregory Phipps – Director, Investment

description

Presentation by venture capitalist, Gregory Phipps, to Chartered Business Valuators - Atlantic Chapter: Nov 22, 2013

Transcript of Valuation models for early-stage technology companies

Page 1: Valuation models for early-stage technology companies

Valuing Early-Stage, Knowledge-based/Tech Companies

November 22, 2013

Gregory Phipps – Director, Investment

Page 2: Valuation models for early-stage technology companies

2

The Challenge• Valuation mix of art (black) & science• In start-up/early-stage, valuation exercise more art than science,

with heavy dose of negotiation thrown in by the investment source (VC’s, angels, etc.)

• Valuation may be used for both negotiated “price” for investment purposes, Founder/Partner buy-out scenarios (more common than you think), marital dissolutions, and third-party acquisitions

• Absence of historic, or (often) accurate means to predict future revenues and cash flow, makes it virtually impossible to use traditional, models like DCF – used frequently by CBV’s

• How do we do it then?

Page 3: Valuation models for early-stage technology companies

3

Alternative Methods Venture Capital Method First Chicago Method Berkus Method Scorecard Method Comparables Negotiation WAG

Page 4: Valuation models for early-stage technology companies

4

Venture Capital Method (Bill Sahlman, Harvard) If we know the value of something in the future

and we know what kind of ROI we need to induce us to make an investment, then we know its “present value” to us.

Eg., I know that by investing $1,000,000 to day at 10% I will have $1,100,000 in one year. I can express this in reverse by saying that the present value of $1,100,000 today at a 10% ROI is $1,000,000.

Page 5: Valuation models for early-stage technology companies

5

Venture Capital Method 1. Forecast future results (”success”)2. Determine likely value at that point (e.g. P/E ratio for

comparable)3. Determine likely dilution from: (a) capital and (b)

employee stock4. Determine share of value “pie” demanded given

required rates of return5. Convert future values to present to derive share

prices, ownership percentages

CASE STUDY: VC looking at three companies. She is unwilling to invest unless she can obtain an annual ROI of 60% in three years from her investment

Page 6: Valuation models for early-stage technology companies

6

Company AM&A

Company BIPO

Company CDotcom M&A

Revenue $100,000,000 $80,000,000 $10,000,000Net Income $15,000,000 $9,000,000 $0IPO/M&A Multiple

6X EBIT 15X Net Income

Dotcom metric 40,000 subs X $1200 per

Future Value $90,000,000 $81,000,000 $48,000,000

Venture Capital Method

Page 7: Valuation models for early-stage technology companies

7

Company A Company B Company CFuture Value in

3 years$90,000,000 $81,000,000 $48,000,000

Present Value @ 60%

$21,973,000 $19,775,000 $11,719,000

Venture Capital Method

With application of funding, divide present value by funds required

Company A Company B Company CPresent Value $21,973,000 $19,775,000 $11,719,000

Funding Needed $5,000,000 $5,000,000 $5,000,000Equity

Surrendered22.7% 25.28% 42.66%

Page 8: Valuation models for early-stage technology companies

8

Venture Capital Method   "Venture Capital Method" of Valuation                

    INPUT    Amount to Invest $1,000,000    Net Income $3,500,000    Year 5   Average P/E Ratio of Profitable Comparable Companies 10   Shares Currently Outstanding 1,000,000    Target Rate of Return 50%             

    OUTPUT    Discounted Terminal Value $4,609,053    Required Percentage Ownership for the VC 21.70%   Number of New Shares Required for the VC's Investment 277,081    Price per New Share $3.61    Implied Pre-money Valuation $3,609,053    Implied Post-money Valuation $4,609,053                       

Page 9: Valuation models for early-stage technology companies

9

First Chicago Method First Chicago approach simply does three

different projections: Best, Worst and Expected cases and assigns probability estimates to each

i.e. Best 25% chance, Worst 35% chance and Expected 40% chance

When utilized, the First Chicago method results in a separate valuation and pricing for each of the three outcomes.

These are than averaged and the valuation and pricing is determined.

Page 10: Valuation models for early-stage technology companies

10

First Chicago MethodFirst Chicago Method *Fill all Yellow Highlighted Areas           Variables Success Sideways Survival Failure           Base Revenue: 0.45     (Average of provided data)                 Revenue growth rate from base: 120.0% 50.0% 5.0%          Projected Liquidation Value @ Year 5 With Failure:   1          After Tax Profit Margin: 20.0% 7.0%            

PE Ratio at Liquidity: 15 7*From Comparables etc. (P/E of 15 is long term historical average)

         Discount Rate: 30.0%*Internal Hurdle             Probability of Each Scenario: 50.0% 30.0% 20.0%          Investment Amount: 0.5                       

Calculations Success Sideways Survival Failure           

         Revenue Growth Rate 1.2 0.5 0.05  (From Base Of ???)        

Revenue Level After 3 Years 4.8 1.5 0.5  

Revenue Level After 5 Years 23.2 3.4 0.6           Net Income at Liquidity 4.6 0.2 0.0  

Value of Company At Liquidity 69.6 1.7 1.0           PV of Company Using Discount 18.7 0.5 0.3  Rate of ????                 Expected PV Of The Company 9.4 0.1 0.1  Under Each Separate Scenario        

Expected PV Of The Company 9.6     

         % Ownership Required in order 4.97%     to Invest $?????        

Page 11: Valuation models for early-stage technology companies

Berkus Method Dave Berkus – noted angel investor, speaker,

author Method only really used or accurate for pre-

revenue companies Still requires subject evaluation/assessment of

key value metrics Really should be called “Keg Steakhouse Method”

or “A La Carte Menu Method” Cast your vote for best name

11

Page 12: Valuation models for early-stage technology companies

12

Berkus Method

Valuation Metric ValueCool idea/concept/tech $.5 million

Experienced management $.5 millionPrototype/build $.25 million

Strategic relationships $.25 millionBoard of Directors $.25 million

Paying customers/traction <> $.5 - $1 million

Page 13: Valuation models for early-stage technology companies

13

Keg Fries (Management) Mixed vegetables (Productized) Rice Pilaf (Distribution partner) Roasted garlic mashed (Board) Baked potato (Customers) Twice baked potato (Business

plan)

The Keg Steakhouse Method

Page 14: Valuation models for early-stage technology companies

Ranks various factors consider predictors of entrepreneurial success

Somewhat subjective but balanced on the whole Best for comparing number of companies against each other, by

type, or by region Company with an avg. product/technology (100% of norm), a

strong team (125% of norm) and a large market opportunity (150% of norm). The company can get to positive cash flow with a single angel round of investment (100% of norm). Looking at the strength of the competition in the market, the target is weaker (75% of norm) but early customer feedback on the product is excellent (Other = 100%). The company needs some additional work on building sales channels and partnerships (80% of norm).

Using this data, we can complete the following calculation:14

Scorecard Method

Page 15: Valuation models for early-stage technology companies

15

Scorecard MethodComparison factor Range Compan

yFactor

Team/Management 30% max 125% 0.375

Size of Opportunity 25% max 150% 0.375

Product/Technology 15% max 100% 0.150

Competition 10% max 75% 0.075

Sales partnerships 10%max

80% 0.080

Additional investment

5% max 100% 0.050

Other factors 5% max 100% 0.050

SUM 1.075

Page 16: Valuation models for early-stage technology companies

Comparables Accurate, reasonable approach to valuation, in

the absence of, or willingness, to apply other valuation methods

Simply research valuations, of similar companies who have raised equity capital, at same stage, in same region

Regional “pricing” applies. Valuations in Atlantic Canada are NOT the same as Silicon Valley

We use DowJones “VentureSource”. Trialing “PitchBook” soon

16

Page 17: Valuation models for early-stage technology companies

17

Negotiation Used more often than not. Follows traditional, age-old premise of “value”:

“what a willing seller and a willing buyer agree upon”

Can be considered a reasonable foundation value (starting point), on which to apply future/next valuation exercises

Probably hard to argue against, retroactively, in legal/court-related testimony of valuation unless one can prove duress

Page 18: Valuation models for early-stage technology companies

18

Wild Ass Guess

Page 19: Valuation models for early-stage technology companies

Bonus: Venture Capital Math $1 million at a $3 million pre-money valuation leading to a $4 million post

money valuation.   The math works out that the investor owns 25% of the company post deal ($1

million invested / $4 million valuation) and assuming 1 million shares, each share would be valued at $3 / share ($3,000,000 pre-money / 1 million shares = $3 / share).  

Investors own 25%, the founders own 75%.  But…… ESOP complicates it, and impacts price/share Assuming a 15% option pool post funding then you need a 20% option pool

pre funding (because the pool gets diluted by 25% also when the VC invests their money).  So your 100% of the company is down to 80% even before VC funding.

The VC’s $1 million still buys them 25% of your company – it’s you who has diluted to 60% ownership rather than 75%.  

The price / share is actually $2.40 (not $3.00), which is $3,000,000 pre-money/ 1,250,000 shares (because you had to create the 250,000 share options).   Thus the “true” pre-money is only $2.4 million (and not $3 million) because $2.40 per share * 1 million pre-money outstanding shards = $2.4 million

19