Valuation of Early Stage Companies A quick primer and discussion April 29, 2016
A brief introduction Venture Carolina: 501(c)(3) that educates investors and entrepreneurs to help improve the market for early stage capital in the Carolinas South Carolina Angel Network (SCAN): network of angel investor groups and funds, including 200+ investors Crowdr.tv: crowdfunding platform that integrates livestreaming and immediate Q&A into fundraising campaigns. SCAN portfolio company based in Charleston.
Your startup is worth exactly. What an investor (or acquirer) is willing to pay!
Theoretically. Valuation = sum of future cash flows, discounted for (high) risk over time What will future cash flows be (hockey stick?) What s the risk (discount rate)? Who knows??? So we have to guess / estimate / triangulate More art than science.
Quick primer on key terms Pre-money valuation Money Post-money valuation Value of company just before investment Amount invested Value of company just after investment = existing shares x new share price Can be complicated by options, warrants, interest = new total shares x new share price
Intro to (some) valuation methods 1. Heuristics 2. Scorecards 3. VC Method
HALO Report benchmark Some caveats: - doesn t account for regional differences - Capital more scarce, therefore more expensive in Southeast - skewed upward by some later stage deals - Influenced by VC pricing valuations already down in 2016 Source: HALO Report: 2015. Angel Resource Institute
Angel round rule of thumb Angels typically want to own 20%-30% (post-money) Some quick math: Raising $500,000 Angels want 25% So, $500K = 25% * Vpost Vpost = $500K/25% = $2,000,000 Vpre = Vpost money = $2M - $500K = $1,500,000 Remember that convertible notes, options, warrants can complicate the amount of money impacting Vpost
Scorecard Payne Method Scorecard Method Developed by Bill Payne (2001) Starts with market-based approach: what valuation band are similar companies valued in? Adjusts value for specific criteria: Strength of management team Size of opportunity vs. competition Sales channel definition Business stage and funding amount Pros: simple, quick, flexible Cons: valuation band debatable, still highly subjective
Scorecard Berkus Method Developed by Dave Berkus (founder member of Tech Coast Angels) in the 1990s Again starts with simple method: baseline of $0.0M then add each of five key characteristics for $0.5M each Quality Management Team Sound Idea Zero Working Prototype Quality Board Product Rollout or Sales Pros not rocket science! Cons misses many factors; value cap $2.5M
VC Method Angel investment $500,000 Exit Year Year 5 Required ROI ~50% IRR = 10x ROI = $5M Exit Year Revenue $10M Comparable transactions 2x revenue Company valuation at exit 2 x $10M = $20M Required share at exit $5M/ $20M = 25% Post-Money Valuation Pre-Money Valuation $0.5M/ 25% = $2.0M $2.0M - $0.5M = $1.5M
What about convertible notes? Avoids valuation altogether (for now) Has become a popular approach, especially in hot markets But angels (usually) prefer equity over convertible debt: Often pier not bridge (no clear conversion event on horizon, exposing investors to significant price risk) Insufficient return: typical 10-30% discount does not adequately compensate earlier investor for extra risk Misaligns company (prefers highest valuation) and investors (prefer lower valuation) at next round Unattractive tax treatment Accruing debt can cripple balance sheet, impair future raises Takeaway: don t be surprised to get push back on note offerings
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VC Method with dilution Angel round New VC Investment Assume $1.00/share 2M total shares $1M for 20% equity Implied post-money = $1M/20% = $5M Pre-money =$5M - $1M = $4M Share price VC Shares =$4M/2M pre-money shares= $2/share = $1M/$2 per share = 0.5M shares Total Shares Angel Ownership 0.5M shares/2.5m shares = 20% Exit Valuation $25M Angel Value = 0.5M + 2M = 2.5M shares Requires larger exit to reach same ROI =$25M*20% = $5M = 10x diluted from 25%