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Valuation of Early Stage CompaniesJames J. Hill Library, St. Paul, MN November 11, 2015
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How are Startups Funded?
Source: Inc. Magazine
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Past Startup Success
Source: FundersandFounders.com
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I’ve identified a problem!!!!
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Startup Process
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Source: StartupCommons.org
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The Traditional Valuation Process
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Valuation of Established Companies
• Traditional Valuation Methods– Asset Approach
– Sum of Asset Values (Cost approach)– Market Approach
– Metric times a multiple– Income Approach
– Present Value of Future Benefits (Cash Flow)
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How is a Startup different?• Established
Company– Revenue and
earnings history– Established
customer base– Accepted product or
service – Proven processes – Stable future growth
• Startup– No revenue or
earnings history– Few or no paying
customers– Testing a new
product or service– New processes– High growth
expectation
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Valuation of an Early Stage Company . . .
Involves Qualitative Assessment of a Number of Factors
Idea!IndustryDefined
MarketOpportunity Founders Advisors
GrowthPotential
Beta/Proof
PrototypeDeveloped
Team Members
Lean & AgileEst GlobalRevenues
Users/Customers
StrategicPartners
IPProtected
$ / HoursInvested
Sales Plan/ Team
BusinessPlan
Competitors
RevenueModel
Gross Margins
Near-TermExpectations
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Drivers of the Valuation
• Stage of the company• The opportunity serves an attractive market• High growth potential• Competition with other funding sources• Strong team• Opportunity may demonstrate capital efficiency• Geographic supply-demand drivers• Exit potential within the target time frame• Current economic climate
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Expected Returns
Source: Pepperdine Cost of Capital Research
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VC Portfolio
Original Annual 5 Yr. ReturnInvestment Return 1 2 3 4 5 Multiple
$100 -50.0% $50 $25 $13 $6 $3 0.0x$100 -50.0% $50 $25 $13 $6 $3 0.0x$100 -50.0% $50 $25 $13 $6 $3 0.0x$100 -50.0% $50 $25 $13 $6 $3 0.0x$100 -50.0% $50 $25 $13 $6 $3 0.0x$100 -12.5% $88 $77 $67 $59 $51 0.5x$100 -12.5% $88 $77 $67 $59 $51 0.5x$100 15.0% $115 $132 $152 $175 $201 2.0x$100 100.0% $200 $400 $800 $1,600 $3,200 32.0x$100 120.0% $220 $484 $1,065 $2,343 $5,154 51.5x
$1,000 $960 $1,294 $2,213 $4,266 $8,673 8.7x
Years
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Venture Capital Portfolio
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Valuation – The Venture Capital Method
Investor’s Rate of Return Based on Risk Taken
- Illiquid Investment (5-7 Years)
- High Failure Rate
- Success is Unpredictable
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Valuation – The Venture Capital Method
Rates of Return = Return Multiples (5 Year Horizon)
20% IRR = 2.5X
40% IRR = 5.4X
60% IRR = 10.5X
100% IRR = 32.0X
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Valuation – The Venture Capital Method
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Valuation – The Venture Capital MethodPost-Money Valuation = Terminal Value ROI Multiple
Software Company AssumptionsSeeking a $500,000 investment
Revenue EarningsYear 5 $20 million $3 millionMedian Multiple 2.0X 15.0XTerminal Value = $40 million $45 million
Assume Terminal Value = $42.5 millionDivide by ROI Multiple 20X
Post-Money Valuation = $2,125,000
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Valuation – The Venture Capital Method
Post-Money Valuation $2,125,000
Less Investment 500,000
Pre-Money Valuation $1,625,000
