70-397 venture finance fall 2002 slide 1 class 9 notes valuation © andrew w. hannah

70-397 Venture Finance Fall 2002

Slide 1

Class 9 Notes

Valuation

© Andrew W. Hannah


Slide 2

Agenda

• Midterm Grades• Homework due tonight

• Winning Angels - valuation• ContentSoft recommendation

• Reflecting…• Recommendations• Valuation

© Andrew W. Hannah


Slide 3

Reflecting…

• What investors do – raise, invest, harvest• Angels vs. VC’s• History and trends• Fund economics• Investment models• Deal sourcing and screening (filters)• Deal evaluation (the entrepreneur and the pitch)• Due diligence• Deal Structure

• Valuation• Contracts and terms

© Andrew W. Hannah


Slide 4

Investment Recommendations

• Goals• Present a clear picture of the company, product and

opportunity• Present the diligence results in a manner that

supports the recommendation• Basis for the recommendation

• Markets – size, growth rate, key features• Competition – direct and indirect, key features,

strength and weaknesses• Comparables – business model, financials, valuation• Valuation – how much? Exit and when?

© William Hulley and Andrew W. Hannah


Slide 5

Investment Recommendations (Cont.)

• What is included in the company’s plan?• The Overview – a presentation of the company’s plan

• Market• Customer• Product• Management• Competition• Competitive Advantages• Financial Overview

• The Diligence• Market• Competition• Comparables• Valuation

• Recommendation – yes or no and why• The diligence memos (as appendices)

© William Hulley

ContentSoft Example


Slide 6

Valuation

© Andrew W. Hannah


Slide 7

Why Are Companies Worth What They Are Worth?

ICGE, Ariba, Cisco

© Andrew W. Hannah


Slide 8

The Fundamentals of a Stock Price

• Share Price= Company Valuation / # of shares

• Company Valuation = Share Price * # of shares

• Share price is what we follow but what is really fluctuating is valuation

© Andrew W. Hannah


Slide 9

So What Is Valuation Anyway?

• Theory versus practice • Theory : Discounted Cash Flows

• Discounted = Net Present Value• Cash Flows = Expected cash inflows less

expected cash outflows• Inflows = Cash from customers• Outflows = Costs to run the company

© Andrew W. Hannah


Slide 10

Present Value Basics• Future Value• You have $1• I guarantee you 10% interest for three

years (or inflation is at 10%)• Your value:

• Year 1: $1.10• Year 2: $1.21• Year 3: $1.33

• You are indifferent!• $1.33 in three years• $1.00 today

© Andrew W. Hannah


Slide 11

Simple NPV

• So….• Discount Rate = 10%• Time = three years• Future Value = 1.33

• What is the NPV?

© Andrew W. Hannah


Slide 12

Back to Valuation…

• Valuation (NPV) = Discount Cash Flows over some period of time

• Discount Rate = 100% (cost of capital)• Year 1 2 3• FCF $10 $20 $30• PV Fctr 1 2 4• PV $10 $10 $7• NPV $52.97 vs. $27

© Andrew W. Hannah


Slide 13

The Real Calculation

• NPV = Discounted Cash Flows (DCF) + DCF year ‘n’ / (cost of capital – growth rate)

• Terminal Value = the new part• Discount rate = cost of capital

• Rate you could borrow/obtain money at to grow your business

• Lower the risk the lower the cost of capital• Low risk = Bank debt (8% or Prime + x%)• Higher Risk = Public Offering (20%)• Highest Risk = Venture capital (50%? 75%? Higher)

• Growth rate = expected annual increase in cash flows

© Andrew W. Hannah


Slide 14

NPV Formula – Cleaned Up

• NPV = Future Value/ (1 + d) ^t• Future Value = cash flow• d = discount rate

• Reflects cost of capital• Risk free rate + risk factor

• t = time (“years”)• Terminal Value: cash flows in perpetuity =

[FCF (year n)/ (d – g)]/ (1 + d) ^ n• g = growth rate of FCF in perpetuity

© Andrew W. Hannah


Slide 15

Valuation Example

• Discount Rate = 10%• Growth Rate = 4%• Year 1 2 3 TV

FCF $10 $20 $30 $30PV Fctr 1 1.1 1.21 1.21PV $10 $18.18 $24.79

$413.22NPV $466.19

• TV= [$30/(10% - 4%)]/ 1.21 = $413.22

(Revisit ICGE and CSCO)

© Andrew W. Hannah


Slide 16

In the End..

• Valuation is based on expectations:• Are cash flow projections realistic• Growth rates• Risk of execution (discount rate)• Sustainable position• Ability to innovate

© Andrew W. Hannah


Slide 17

Valuation Methods For Entrepreneurial Companies

• Discounted cash flow?Multiples of public companies and sale of private companies:

SalesEarnings (current/future)Customers?

Negotiation

Remember: discount rates = risk and required rate of return = cost of capital

© Andrew W. Hannah


Slide 18

Use of Proceeds

Pre-Money Determinant Key MV

Drivers

“Plan in Hand” Proto-type Research

Formulaic ($2 - $6 M)

Founder Experience

Post-Seed (“A”) Proof of concept

Negotiation ($8 - $15)

Tangibles/ Intangibles

Early Growth (“B”)

Mgmt TeamCustomers

Negotiation ($15 - $30M)

Tangibles/ Intangibles

High Growth (“C”, “D”)

ExpansionAcquisition?

Comp Driven ($45 - $55M)

Public/Private Transactions

Valuation Methods By Stage

© Andrew W. Hannah


Slide 19

What Makes a Difference?

• The team’s experience• Stage of development• Customers• Protectable IP• Economic conditions• Size of the opportunity• Other

© Andrew W. Hannah


Slide 20

Valuation Strategy

• Entrepreneurs must triangulate (dcf and public & private multiples)

• VC’s:• Discount projections• Look for 55% discount factor• Look hard at public and private multiples

• Entrepreneurs best strategy: create an auction

© Andrew W. Hannah


Slide 21

Pre- and Post-Money Valuation

• Pre-money valuation = value of the company before the investment round

• Post-money valuation = value of the company after the investment round

• Example• You own 50% of a company• Pre-money valuation = $10 million• You are raising $5 million• What is the post-money valuation?• What is your new ownership percentage?

© Andrew W. Hannah


Slide 22

Next Week

• Contracts and Control• Diligence Card “B” – comparables• WA: 179 – 222 (this is different than the

syllabus)

© Andrew W. Hannah

70-397 venture finance fall 2002 slide 1 class 9 notes valuation © andrew w. hannah

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