Valuing Early Stage Companies

Transcription

1 Valuing Early Stage Companies or how to appear that you can negotiate with a sophisticated investor Jan Klein THP, LLC jklein973@gmail.com January 16, 2014

2 Beauty or Value is in the eyes of the beholder Financial Investors Strategic Friends and Family Synergistic players Angels Competitors Venture Capitalists

3 What constitutes value Hard Assets Ideas/Products Individuals/Teams

4 How value is assigned (GAAP) Others: Real Options/stochastic Cost Basis Market approach Incomes method Theory Accounting at the lower of cost or market Benchmarking against what comparable firms trade at Intrinsic financial theory of asset value = sum of discounted free cash flows Predictive ability Excellent Generally good in short run Key driver/ limitation Start-up applicability Replacement cost is accounting not economic value Very limited Finding comparable transactions Nice if you can obtain this data Speculative due forecast uncertainty Ability to predict the future Most often used by sophisticated VCs

5 If there is NO Investment to fund the business plan then there is only liquidation or NO value The Pre and Post Money Concept Pre-money Value + Investment = Post-money Value As a general rule entrepreneurs focus on Post-money Value Intrinsic Values (sum of FCF) implies available financing and hence is a Post-money concept

6 Simple example of pre/post: Shark thank mathematics If an investor tells you that they will give you $1M for 25% of your company they are telling you: 1. That with their money invested; you are a $4M company (Post money or $1M/25%); 1. Without you re their money invested; you are a $3M company (Pre money or $1M/25% less $1M)

7 What you can expect Source: Kaufmann Foundation:

8 VENTURE RETURNS BY STAGE

9 Cost Based Approach Theory: Investor values your firm s assets based upon the total replacement cost Practicalities: Difficulties is estimating costs: Gross/Net Book; Economic/technical life, comparability, etc. Treats everything as a commodity Often ignores the intangibles : Compelling or proprietary use of the assets Value of the team and/or start-up expenses incurred Market window or time to market Implementation GAAP Balance Sheet analysis: Audit Cash, A/R, A/P, Inventory, etc. Problems with IPR and intangible components

10 Cost Based Applications Most often used in special situations Liquidations Mature industries; Patent rich firms or where liabilities are very significant i.e. Commercial Banking: Net Tangible Book Value Acquisitions + Replacement ( make vs. buy ) decisions Rarely for start-ups or pre-revenue firms

11 Market based Approach Theory: Investor is willing to pay a discount or premium to prevailing market prices for same item Practicalities: Difficulties is comparable companies and market transactions Adjustments need to be made for: Product and/or customer mix Stage of Development/Private v. Public Timing of the transaction Implementation Identify comparable market transactions (M+A/IPO or Disposition) Develop multiples either Price (equity) or Enterprise (equity + debt) relative to a financial/operating metric for a public firm use to value Financial multiples: Price/Sales; Price/Earnings or Price/Cash flow or Operating multiples: Price/ website hits, downloads, users, etc. etc.

12 Benchmarking using market based transactions Comparison with comparable sales transactions Often must adjust for differences in size or development stage of the firm Always have to adjust for differences in Public verses Private Benchmark with quoted sales price of similar companies For Private firms (early stage) the market value can be based upon: The current investment value after taking into account liquidation preferences and participation rights Adjusting for lack of liquidity and/or lack of control (if comparing to Public)

13 Market Based: Transaction Multiples

14 Market based using public stock trading multiples While not generally applicable to pre-revenue firms; it can be used if you can forecast future cash flow and then discount to the present Develop multiples either Price (equity) or Enterprise (equity + debt) relative to a financial/ operating metric for a public firm use to value Typical multiples: P/E; P/Rev; P/Op Inc.; P/Book Value Preference is to use enterprise value, relative to EBITDA:

15 Enterprise Value Economic Value Balance Sheet PV of future cash from business operations Or ASSET VALUE $1500 Cash $200 Debt $650 Marketable securities $150 Equity $1200 $1850 $1850 Enterprise Value Remember Enterprise Value = Assets which = Debt +Equity 15

16 Using Enterprise Multiples (EV): Multi-yr. view Don t rely upon one year or one data point

17 Incomes or Earnings Approach Theory: Investor values your firm s assets based upon how much cash flow can be generated in today s $ terms Practicalities: Values highly dependent upon future cash flow and discount rate estimates Difficult and complex calculations Must be supported by a comprehensive business plan Yields a private value for 100% of the assets and ignores the haircuts that investors give to lack of liquidity and lack of control Implementation Forecast Free Cash Flow = NOPAT less CAPEX +/- change in Wkg, Cap Develop estimates of discount rates (expected Investors ROR)

18 Financial Analysis - Objectives

19 The Incomes or DCF Model

20 Template for Free Cash Flow Working capital Income Statement Year Revenue Costs Depreciation of equipment Profit/Loss from asset sales Taxable income Tax Net oper proft after tax (NOPAT) Depreciation Profit/Loss from asset sales Operating cash flow Change in working capital Capital Expenditure Salvage of assets Free cash flow Noncash item Noncash item Adjustment for for non-cash Capital items

21 Forecasting Operating Cash Flows (INTEL EX)

22 Preparing Free Cash Flow projections (INTEL EX)

23 Choosing discount factors WAAC (INTEL EX)

24 Discount rates used by VC s

25 Determining exit Multiple EV/EBIT (INTEL EX)

26 Final Valuation Determination (INTEL EX)

27 QUESTIONS Following Charts are All Back-Up

28 DEAL STRUCTURE

29 Finding a VC

30 The Pitch

31 Evaluating a Business Plan

32 What VCs Look For: Fit Segment Industry (healthcare, IT, wireless) Product/ business model (e.g. SW, HW, chips) Technology area (e.g. Open Source, propreitary) Geography Some won t get on planes Some have limitations on international Some have a specific mandate Stage Seed/Startup Pre-revenue Revenue Expansion Mezzanine

33 Employee Ownership

34 Things to Remember #1 The VC would rather be here They do not have the same vested interest you do They are naturally more skeptical than you are as they have seen 10x more failures than successes They will still collect a paycheck on Friday

35 Economics of Private Equity (VC) Deal Investment Return Gain/Loss % 1 5,000,000 50,000, % 2 5,000,000 30,000, % 3 5,000,000 12,500, % 4 5,000, % 5 5,000,000-2,500,000-50% 6 5,000,000-3,500,000-70% 7 5,000,000-3,500,000-70% 8 5,000,000-5,000, % 9 5,000,000-5,000, % 10 5,000,000-5,000, % Total 50,000,000 68,000,000 36%