Valuation models for early-stage technology companies
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Transcript of Valuation models for early-stage technology companies
Valuing Early-Stage, Knowledge-based/Tech Companies
November 22, 2013
Gregory Phipps – Director, Investment
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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?
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Alternative Methods Venture Capital Method First Chicago Method Berkus Method Scorecard Method Comparables Negotiation WAG
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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.
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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
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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
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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%
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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
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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.
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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 $?????
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
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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
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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
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
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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
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
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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
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Wild Ass Guess
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
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