Slide deck on valuation models for early-stage knowledge-based/technology companies delivered to The Canadian Institute of Chartered Business Valuators - Sept 18, 2014
2. 2
The Challenge
• Valuation mix of (black) art & 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 equity
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 figure out its “present value” to us.
Present value = valuation
Incorporates some elements of DCF insomuch that we apply
risk premium (expressed as return/discount/hurdle rate), and
are determining PV, but it is based on future terminal value
rather than cash flows
No time/value of money considered
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Venture Capital Method
1. Forecast future results (”success”) vs current situation (more optimistic?)
2. Determine likely value at that point (e.g. P/E ratio for comparable)
3. Determine likely dilution from: (a) equity capital issuance and (b)
employee stock option grants
4. Determine share of value “pie” demanded given required rates of return
5. Convert future values to present to derive share prices, ownership
percentages
Terminal (exit) value ÷ post-money valuation = return on investment
or,
Post-money valuation = terminal value ÷ anticipated ROI
CASE STUDY: VC looking at three companies. She is unwilling to invest
unless she can obtain an annualized return of 30% from her investment
6. Company A
M&A
Company B
IPO
Company C
SaaS M&A
Revenue $100,000,000 $80,000,000 $10,000,000
Net Income $15,000,000 $9,000,000 $0
IPO/M&A Multiple 6X EBIT 15X Net Income
SaaS metric 40,000 subs X
$1200 per
Terminal Value $90,000,000 $135,000,000 $48,000,000
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Venture Capital Method
7. Company A Company B Company C
Terminal Value $90,000,000 $135,000,000 $48,000,000
Post Money =
Terminal Value/30%
(ROI)
$3,000,000 $4,500,000 $1,600,000
Subtract
Investment
$1,000,000 $1,000,000 $1,000,000
Pre-Money $2,000,000 $3,500,000 $600,000
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Venture Capital Method
8. 8
Venture Capital Method
"Venture Capital Method" of Valuation
INPUT
Amount to Invest $ 1,000,000
Net Income $ 8,000,000
Year 5
Average P/E Ratio of Profitable Comparable Companies 10
Shares Currently Outstanding 9,989,640
Target Rate of Return 50%
OUTPUT
Discounted Terminal Value $ 10,534,979
Required Percentage Ownership for the VC 9.49%
Number of New Shares Required for the VC's Investment 1,047,683
Price per New Share $ 0.95
Implied Pre-money Valuation $ 9,534,979
Implied Post-money Valuation $ 10,534,979
9. 9
First Chicago Method
First Chicago approach simply does three different
projections: Best, Worst and Survival scenarios &
assigns probability estimates to each
i.e. Success - 30% chance; Failure - 20% chance; and
Survival - 50% chance
When utilized, the First Chicago method results in a
separate valuation for each of the three potential
outcomes.
These are than added and the valuation and pricing is
determined.
10. 10
First 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: 30.0% 50.0% 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 4.79 1.52 0.52
Revenue Level After 5 Years 23.19 3.42 0.57
Net Income at Liquidity 4.64 0.24 0.00
Value of Company At Liquidity 69.57 1.67 1.00
PV of Company Using Discount 18.74 0.45 0.27
Rate of ????
Expected PV Of The Company 5.62 0.23 0.05
Under Each Separate Scenario
Expected PV Of The Company 5.90
11. BerkusMethod
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
I have renamed it the “Keg Steakhouse Method” or “A
La Carte Menu Method”
Cast your vote for best name
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BerkusMethod
Valuation Metric Value
Cool idea/concept/tech $.5 million
Experienced management $.5 million
Prototype/build $.25 million
Strategic relationships $.25 million
Board of Directors $.25 million
Paying customers/traction <> $.5 - $1 million
14. Not really a “valuation method” in itself
Ranks various factors consider predictors of entrepreneurial success
Somewhat subjective but balanced on the whole
Best for comparing a 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:
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Scorecard Method
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Scorecard Method
Comparison factor Range Company Factor
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 100% 1.075
16. Comparables
Accurate, reasonable approach to valuation, in the
absence of, or willingness, to apply other valuation
methods
Court tested?
Simply research valuations, of similar companies who
have raised equity capital, at same stage, in same
region
Regional “pricing” applies. Valuations in Canada are
NOT the same as Silicon Valley
We use DowJones “VentureSource” and “PitchBook” to
research comparable valuations as reported in VC deals
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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
19. 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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