3. What is the Valuation of a Company?
The price to buy the entire company (i.e., Microsoft will buy LinkedIn for $26
billion).
If “100% of the company is offered for $1 million,” it’s the valuation for the
acquirer.
Valuation is not-so-obvious when a fractional interest is sold; investors
calculate valuation differently. To an investor, $1 million is the valuation if:
50% is offered for $1 million
66% is offered for $2 million
33% is offered for $0.5 million
I will show you how to make sense of this and how to calculate the valuation
from an investor’s perspective!
4. Value vs. Worth
“Valuation” is a slippery word…its meaning is context sensitive.
A company’s valuation is it’s price, not it’s worth.
A company’s market value reflects the most recent price for a piece or share of it.
If someone says a company is overvalued, they mean it is overpriced.
If they say a company is undervalued, they mean it is underpriced (a bargain).
Valuation experts use valuation to mean what they think a company may be
worth…considering evidence of both worth and market value.
5. What is “Worth?”
We sense worth for what we derive utility from (home, clothing, food).
We sense if a house is worth $1 million, a pair of pants is worth $60 or a sandwich is
worth $5.
We struggle to sense worth in investments—art or securities. That’s
because they lack utility.
Nonetheless, valuation is important if you want an attractive return on an
investment.
Determinants of a return on investment:
Price paid (buy-in valuation)
Price received (exit valuation)
Length of time investment held
Our focus
6. Pre-Money vs Post-Money Valuation
Another reason “valuation” is a slippery term:
There is a “pre-money valuation” and “post-money valuation”
And which one is important depends on the context, which the next table will
explain.
7. Which Valuation is Important When?
Private Company Public Company
Pre-Money
Valuation
Post-
Money
Valuation
Important for an IPO—the initial price
setting in the public market.
Moot point for a secondary offering—it
generally is the market price.
Interesting but unimportant; no
secondary market.
Important
Important—it is the market
capitalization.
What is important—pre-money
valuation of next round of capital.
8. Pre-Money Valuation- Simplified
It depends on “when”—before or after you put $20 in the pocket.
If the pants are worth $20 (fairly priced) before your $20, it is now worth $40
Imagine you are checking out a pair of pants offered for sale for $20.
You put $20 in the pocket. What is the value of the pants?
Price of the pants $ 20
Money you put in the pants pocket 20
Value of the pants with your money $ 40
Overpriced
$ 15
20
$ 35
Underpriced
$ 30
20
$ 50
But…if worth $30 to begin with (underpriced), the pants are now worth $50
On the other hand, if only worth $15 (overpriced), they are now worth $35
9. Why is Pre-Money the Key Figure?
Price of the pants $ 20
Money you put in the pants pocket 20
Value of the pants with your money $ 40
Equivalent for a company
Pre-money valuation
The Offering
Post-money valuation
Pre-money is the price before the offering (i.e., new money).
Relevant question is the asset—pants or company—worth the price
before the offering (i.e., before the new money is added)?
10. Two Ways to Calculate Valuation
1. Shares Outstanding Method
Number of shares outstanding before the offering
Number of new shares offered
Price of a new share
2. Percentage of Ownership Method
Total amount of money to be raised in offering
Percentage of company to be sold in offering
What is
known
determines
the method
to use
11. Share Method Calculation
Pre-Money Valuation Number of Shares Outstanding
Before the Investment
= X Price of a New Share
Example : ABC Company has 10 million shares outstanding and plans to raise $5 million. It
offers 1 million new shares at $5 per share. So, it’s pre-money valuation is $50 million.
$50 million = 10 million shares X $5 per share
The relationship between the pre- and post-money valuation:
$ 50 million Pre-money valuation ( 10 million shares X $5 per share)
+ 5 million Money raised (1 million shares X $5 per share)
-----------------
$ 55 million Post-money valuation (11 million shares X $5 per share)
12. Percentage Method Calculation (1 of 3)
This calculation takes a few steps that we’ll follow in a new example.
◦ Let’s say another company, XYZ, seeks to raise $10 million in exchange for 10% of
the company.
◦ What is the pre-money valuation of XYZ Company?
The relationship between money and valuation can be expressed as either:
1. Pre-money valuation + Money = Post-money valuation
2. Post-money valuation – Money = Pre-money valuation
3. Pre-money valuation = Post-money valuation – Money
Pre-money valuation is in bold as a reminder that its the figure we’re interested in.
The next slide references this
13. The Percentage Formula (2 of 3)
The formula to calculate pre-money valuation using the percentage method:
Pre-Money
Valuation
= - Investment
Amount
Investment Amount
Percentage of the Company for Sale
The Post-Money Valuation
Investment Amount
Percentage of the Company for Sale
And that,
The formula boils down to this:
◦ Pre-money valuation = Post-money valuation - Money
=
When you recognize that
Investment Amount=The Money
14. Apply the Percentage Formula (3 of 3)
So, let’s figure out XYZ’s pre-money valuation if $10 million buys 10% of the company.
$10,000,000 investment
0.10 (10% of XYZ)
= $100,000,000 XYZ’s post-money valuation
$100,000,000
XYZ’s post-money valuation
=- $10,000,000
Money XYZ seeks to raise
$90,000,000
XYZ’s pre-money valuation
Table presentation
XYZ Company Valuation
Pre-Money Valuation $ 90 million
Money (the Offering) 10 million
Post-Money Valuation $ 100 million
Proof
Ownership
90%
10%
100%
15. Percentage Calculation Not Intuitive
Unless you are a math whiz, you’ll need a calculator to compute valuation
using the percentage method.
If you think you can eyeball it, be careful.
16. If $10 million buys 100% of
the company, it’s pre-money
valuation is zero.
If $10 million buys 50%, the pre-money
valuation is $10 million
If $10 million buys 1% of the company, it’s pre-money
valuation is $990 million
Because
Valuation
is
Non-Linear
Handy rule: If half the
company if for sale, the
pre-money valuation is
the amount of the
offering.
Other amounts are not
intuitive.
Valuation changes in a non-linear manner as the
percentage of the company purchased changes.
17. Things that Cloud a Valuation
The right to acquire stock in the future at a
lower price than new investors can cloud
the significance of a pre-money valuation.
Restricted Stock
Stock Options or
Warrants
Convertible Debt
Examples:
◦ Restricted stock
Multi-Class
Capital Structure
◦ Stock options and warrants
◦ Convertible Debt
◦ Multi-class capital structure—because such a
structure enables special terms
18. Terms Can Ecilpse a Valuation
Special terms granted to some investors
can make a pre-money valuation somewhat
meaningless for other investors.
Price protection
◦ Price Ratchet provides a retroactive price
reduction if later investors get a lower
valuation.
Preferential return
◦ Liquidation Preference: enables an
investor to get a multiple (e.g., 2X) of
investment back before others get
anything at all.
Redemption Right
◦ Obligates company to buy back
shares.
VCs rely more on getting the right
terms than getting the pre-money
valuation right.
◦ Because it is hard to reliably figure out
what a company is worth.
A company must have a multi-class capital
structure to grant special terms.
◦ Single-class: All for one and one for all
◦ Multi-class: All investors are shareholders,
but some shareholders are more equal
than others
Multi-class capital structures are common in
private companies that have VC/PE investors;
far less common in public companies.
19. Want More Food for Thought?
Check out The Fairshare Model, the book I’m writing.
Its about a performance-based capital structure for
companies that raise venture capital via a public offering.
I call it the Fairshare Model because it balances and aligns
the interests of investors and employees
Target Audience: anyone who might want to invest in or
work for a venture-stage company…or has interest in
economics, philosophy or organizational structure
Preview it: visit www.Inkshares.com and search for
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20. Fairshare Model: a crowd-vetted book
Section I – Overview
Chap. 1 – The Fairshare Model
Chap. 2 – Orientation
Chap. 3 – Brief Q&A
Chap. 4 – The Problem With a
Conventional Capital Structure
Chap. 5 – Crowdfunding
Chap. 6 – Target Companies
Chap. 7 – Fairshare Model
History & Projection
Section II – Macro Context
Chap. 8 – Economic Growth
Chap. 9 – Income Inequality
Chap. 10 – Cooperation as a
Tool for Competition
Chap. 11 – Tao of the
Fairshare Model
Section IV – Fraud, Failure &
Other Objections
Chap. 16 – Three Causes of
Investor Loss: Fraud,
Overvaluation & Failure
Chap. 17 – Failure
Chap. 18 – Other Objections to
Public Venture Capital
TBD – Secondary Markets, Accounting Issues, Game Theory, Behavioral Finance and wrap-up
Full draft at www.fairsharemodel.com
Section III – Valuation
Chap. 12 – Concepts
Chap. 13 – Calculation
Chap. 14 – Evaluation
Chap. 15 – Disclosure
Pre-Order Bonus: Special version of chapter 13; it has tables to
look-up a pre-money valuation based on % of company sold.
When you pre-order The Fairshare Model you get a bonus!
21. Pre-Money Valuation
Table Bonus
Benefits of the table:
• Pre-money valuation without calculation
• Makes “what-if” scenarios easier
• Better perspective on valuation
How it works:
• Find column with offering size
• Find row with % of ownership offered
• Intersection is pre-money valuation
Range: offerings from $0.5 to $26 million,
in $0.5 million increments
If a company offers X% of its equity for an
investment of $Y, what is the pre-money
valuation?
22. Fairshare Model Pre-Order Benefits
1. Discounted price on e-book or an e-book/print combo.
2. Print copies are signed!
3. Bonus: Valuation Calculation chapter with Pre-Money Valuation Tables.
4. You help promote a movement to re-imagine capitalism!
◦ Performance-based capital structures are not new—many private offerings use
one. But their use in an IPO is revolutionary!
23. How to Pre-Order the Fairshare Model
Visit www.Inkshares.com and search for “Fairshare Model”
◦ Direct link https://www.inkshares.com/projects/the-fairshare-model
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The Fairshare Model will be published about five months after 250 pre-orders are
received. If the goal is not met, your money will be refunded.
Thanks for watching!