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How much is my company worth? The importance of valuation
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• Valuation is the total price of a company at a specific point in time
• In short, your company is worth what an investor is willing to pay for it (ie what the market says it’s worth)
What is Valuation?
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When should you valuate business?
• Entrepreneurs will look to valuate their company prior to raising funds, as the amount you want to raise determines valuation
• Raise just enough to achieve next milestone, and then come back with higher valuation
• Entrepreneurs should approach the negotiating table with a well formulated and supported valuation.
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Why is it so Difficult?
• “Valuation is more an art than a science”
• While there are commonly used methods to estimate company value, rarely if ever are they the official “Valuation” of the company
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Why is it so Difficult?
• Due to the factors mentioned earlier (market, industry comparisons, company performance, etc), valuation is very volatile and unpredictable
• Raising money puts a very un-ambiguous stamp of “worth” on what you’ve worked so hard to create
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Difficulties for Early-stage Businesses
• For Early-stage businesses (which are almost always private), this is even more difficult:
–Lack of historical data–Lack of effective comparables (reporting and like-to-like)–Lack of proof of concept
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• A lot of it comes down to negotiation
• The market wants a winner – it’s your job to convince the investor that their investment can lead to exponential growth
Difficulties for Early-stage Businesses
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Bottom Line
• Be reasonable – value comes in with investment, so doesn’t matter what numbers say, it’s about market validation
• No point valuing yourself high if no one invests in you
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Q&A
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Valuation Methods
• Comparables/Multiples
• Discounted Cash Flow (DCF)
• Cost to Duplicate
• Berkus
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Method 1: Market Multiple (Comparables)
• The market multiple approach values the company against recent acquisitions of similar companies in the market.
• This method is a VC favourite, as it gives them a good idea of what the market is willing to pay for the company
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Market Multiple (Comparables)
• First, you find a list of the closest companies to you• i.e. industry, size, market performance
• A multiple is then assigned based on financial figures, such as:–EV/Sales–EV/EBITDA
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Market Multiple (Comparables)
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Market Multiple (Comparables)
• Advantages:
–Accurate and indicative of market demand
–This gets us closest to the answer above that “valuation is what the market will pay.”
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Market Multiple (Comparables)
• Disadvantages:
–Difficult to find close multiples for early stage companies
–Private companies do not disclose figures
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Method 2: Discounted Cash Flow Method
• The value of a company today is equal to the present value of the future cash flows discounted at a rate that reflects the riskiness of those cash flows.
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Discounted Cash Flow Method
• In English, this means a company is worth today what it can potentially achieve tomorrow.
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• Relies on the Time Value of Money principle, which assumes that a dollar today is worth more than a dollar tomorrow
Discounted Cash Flow Method
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Discounted Cash Flow Method
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Discounted Cash Flow Method
Step 1: Forecast finance projections
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Discounted Cash Flow Method
• Step 2:
• Determine discount rate
• This is based on risk and potential return of the business:
• For early-stage businesses this tends to range from 20 - 50%
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Discounted Cash Flow Method
Step 3: Apply formula
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Discounted Cash Flow Method
• Advantages:
–Allows a company to value itself based on its future potential
–For companies with no comparables or tangible assets
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Discounted Cash Flow Method
• Disadvantages:
–A very volatile method
–Forecasting is often inaccurate
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Q&A
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Method 3: Cost to Duplicate
• Assumes a company is worth how much it would cost to build another company just like it from scratch.
• The idea is that a smart investor wouldn't pay more than it would cost to duplicate.
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• We’re in the shoe making business:
• $250,000 for 18 months development• $50,000 equipment• $150,000 labor costs
• Therefore, it would cost $450k to duplicate
Cost to Duplicate
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Cost to Duplicate
• An example of this is the Yahoo purchase ($164m) of Maktoob • They bought it because it would take 18 months to build Arabic
functionality
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Cost to Duplicate
• Advantages:
–Easy and quick
• Disadvantages:
–Unreliable when it comes to intangible assets
–Doesn’t measure the potential of the business
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Method 4: Stage (Berkus)
• Values company based on the venture's stage of commercial development
• The further the company has progressed along the development pathway, the lower the its risk and the higher its value.
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Method 4: Stage (Berkus)
• Often used by angel investors
• Quick, rough-and-ready range of company value
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Stage (Berkus)
• Quality of the Management Team
• The soundness of the idea
• Whether there is a working prototype
• The Quality of the Board
• Product Rollout / Sales
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Stage (Berkus)
• A valuation-by-stage model might look something like this:
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• Advantage:
–Quick and easy
–Checklist
• Disadvantage:
–Overly simplistic and generic
Stage (Berkus)
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Q&A
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So What Can You Do?
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Combine
• DCF = 1,000,000• Multiples = 750,000• Berkus = 1,500,000• Duplicate = 500,000
• Take an average: $900,000
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Tell a good story
• A valuation is only as good as you can sell it — an investor is really interested in what a business can become rather than what it is now.
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A final takeaway
• Be reasonable – value comes in with investment, so does’t matter what numbers say, it’s about market validation
• Valuation is also contingent on the terms — more generous terms can yield a higher valuation.
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Q&A
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Thanks for attending. We hope you enjoyed it.
(Don’t forget to fill in the four-question survey.)