basic start up valuation - how much r u worth
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START-UPBASIC
VALUATIONHOW MUCH ARE YOU WORTH?
INTRODUCTION: DUDE, DON'T FREAK
I KNOW WHAT YOU ARE SAYING…
I KNOW WHAT YOU ARE SAYING…
OH GOD. ANYTHING
BUT FINANCE.
BUT, SERIOUSLY. DON'T SWEAT IT. I KNOW WHAT YOU ARE SAYING…
OH GOD. ANYTHING
BUT FINANCE.
BUT, SERIOUSLY. DON'T SWEAT IT. I KNOW WHAT YOU ARE SAYING…
OH GOD. ANYTHING
BUT FINANCE.FINANCE IS ACTUALLY QUITE SIMPLE
BUT, SERIOUSLY. DON'T SWEAT IT. I KNOW WHAT YOU ARE SAYING…
OH GOD. ANYTHING
BUT FINANCE.FINANCE IS ACTUALLY QUITE SIMPLEWHEN YOU FOCUS ON WHAT MATTERS.
AND YOU CAN'T AVOID IT.
AND YOU CAN'T AVOID IT.BECAUSE IF YOU LOOK WEAK
AND YOU CAN'T AVOID IT.BECAUSE IF YOU LOOK WEAKIF YOU ACTUALLY LET EXCEL KNOW YOU'RE SCARED
AND YOU CAN'T AVOID IT.BECAUSE IF YOU LOOK WEAKIF YOU ACTUALLY LET EXCEL KNOW YOU'RE SCAREDTHEN YOU'LL BE ON
YOUR ASS
SO LET'S TALK ABOUT VALUATION
SO LET'S TALK ABOUT VALUATIONSINCE YOU CAN’T
AVOID IT
SO LET'S TALK ABOUT VALUATIONSINCE YOU CAN’T
AVOID ITSINCE IT'S NOT ACTUALLY
THAT HARD
SO LET'S TALK ABOUT VALUATION
SINCE IT'S NOT ACTUALLY THAT HARD
AND SINCE IT IS ONE OF THOSE TOPICS THAT
ABSATIVELY CANNOT BE DELEGATED TO FINANCE
SINCE YOU CAN’T AVOID IT
VALUATION IS THE PROCESS OF
DEFINING WHAT YOUR START-UP
IS WORTH!DEFI
NIT
ION
DEFI
NIT
ION VALUATION IS
THE PROCESS OF DEFINING WHAT YOUR START-UP
IS WORTH!
YOU DO THAT IN 3 SIMPLE WAYS
DEFI
NIT
ION VALUATION IS
THE PROCESS OF DEFINING WHAT YOUR START-UP
IS WORTH!
YOU DO THAT IN 3 SIMPLE WAYS
YOU'RE WORTH WHAT YOU OWN
DEFI
NIT
ION VALUATION IS
THE PROCESS OF DEFINING WHAT YOUR START-UP
IS WORTH!
YOU DO THAT IN 3 SIMPLE WAYSYOU'RE WORTH WHAT YOU
OWNYOU'RE WORTH WHAT YOU CAN EARN IN THE FUTURE
DEFI
NIT
ION VALUATION IS
THE PROCESS OF DEFINING WHAT YOUR START-UP
IS WORTH!
YOU DO THAT IN 3 SIMPLE WAYSYOU'RE WORTH WHAT YOU
OWNYOU'RE WORTH WHAT YOU CAN EARN IN THE FUTUREYOU'RE WORTH WHAT THE
MARKET SAYS YOU'RE WORTH
LET'S GO THROUGH EACH OF THOSE…
PART 1 YOU'RE WORTH WHAT YOU
OWN
VALUATION BASED ON ACTUAL ASSETS IS PROBABLY THE SIMPLEST
AND MOST INTUITIVE
YOU ARE WORTH EXACTLY HOW MUCH YOU HAVE IN YOUR POCKET!
* (ADVANCED READER: WHAT IS IN YOUR BALANCE SHEET TODAY?)
ACTUALLY, WHAT YOU’RE WORTH RIGHT NOW CAN BE DIVIDED INTO 2
MAJOR CATEGORIES OF VALUE
TANGIBLE ASSETS INTANGIBLE ASSETS
INVENTORYCASH OR FINANCIAL ASSETSBUILDINGS, LAND, VEHICLES, EQUIPMENTCOMPUTERS, DESKS, CHAIRS (ANYTHING YOU CAN HOCK)ACCOUNTS RECEIVABLE (WHAT PEOPLE OWE YOU)AGREEMENTS THAT COULD BE NOVATED (FRANCHIZE OR DISTRIBUTION AGREEMENTS)
COPYRIGHTSPATENTS
TRADEMARKSTRADE SECRETS
BRAND / REPUTATIONUNIQUE KNOWLEDGE
SO THE FIRST THING YOU NEED TO DO IS FIGURE OUT HOW MUCH YOU CAN
SELL ALL THE TANGIBLE & INTANGIBLE ASSETS FOR
BUT…
YOU’LL PROBABLY ALSO HAVE SOME LIABILITIES TOO
RENTAL AGREEMENTSACCOUNTS PAYABLE
BANK LOANSUNPAID SALARY
SALARY LIABILITIES (NOTICE PERIODS)TAX OWED
BONDSLEASES
PENSION CONTRIBUTIONPRODUCT WARRANTIES
OTHER CONTINGENT LIABILITYSHAREHOLDER DEBT
YOU NEED TO SUM UP ALL THESE LIABILITIES AS WELL
AND WHEN YOU DO THAT, YOU’RE READY TO VALUE YOUR FIRM:
FIRM VALUE = (TANGIBLE + INTANGIBLE ASSETS) - LIABILITIES
SIMPLE RIGHT?
WELL SIMPLE COMES AT A COST
OF THE 3 METHODS, THIS RESULTS IN THE LOWEST VALUATION
WHICH IS WHY, IT IS REALLY ONLY USED DURING LIQUIDATIONS
PART 2 YOU'RE WORTH WHAT YOU CAN EARN IN THE FUTURE
OF COURSE THE ASSETS & LIABILITIES METHOD DOES NOT WORK WELL WHEN
YOU ARE PITCHING A TRUE START-UP WHICH HAS NOTHING OTHER THAN A
BIG DREAM
BECAUSE YOU HAVE NO ASSETS
IN THAT CASE, WE NEED TO VALUE THE BUSINESS BASED UPON WHAT IS
POSSIBLE IN THE FUTURE
BUT WAIT? WHY WOULD ANYONE PLACE A VALUE ON POSSIBLE
FUTURE MONEY
WELL IT TURNS OUT THAT POSSIBLE FUTURE MONEY DOES HAVE VALUE
DEPENDING ON HOW POSSIBLE, AND HOW MUCH FUTURE MONEY WE’RE
TALKING ABOUT
THINK OF IT THIS WAY
IF YOUR MOTHER TOLD YOU SHE’D GIVE YOU 20 DOLLARS TOMORROW IF YOU
DID 1 HOUR OF CHORES TODAY, WOULD YOU DO IT?
SURE YOU WOULD
WHAT A GOOD CHILD
YOU TRUST MOM. YOU NEED THE DOUGH TOMORROW. SO YOU’LL PAY IN
ADVANCE
YOU SEE. PROMISED FUTURE MONEY DOES HAVE VALUE TODAY
HOW ABOUT IF A BANK TOLD YOU THAT THEY’D GIVE YOU A GUARANTEED 110
DOLLARS IN A MONTH IF YOU DEPOSITED 100 DOLLARS TODAY?
SURE YOU WOULD
THE POINT IS THAT THERE IS DEFINITELY VALUE TODAY FOR FUTURE MONEY
HOWEVER, THERE IS A LIMIT
THE VALUE OF FUTURE MONEY AND THE VALUE OF MONEY TODAY IS NOT
EQUAL
WOULD YOU PAY ME 100 DOLLARS TODAY IF I PROMISED THAT I’D RETURN
100 DOLLARS IN 10 YEARS?
COME ON…YOU CAN TRUST ME. I’LL PM YOU MY BANK DETAILS
NO, OF COURSE NOT
FIRST, IF YOU DEPOSITED THE 100 BUCKS IN A BANK, YOU’D GET MORE
THAN 100 BACK IN TEN YEARS BECAUSE OF INTEREST
(WELL MAYBE NOT MUCH MORE)
IN OTHER WORDS, THE VALUATION OF FUTURE PROMISED MONEY IS
AFFECTED BY OPPORTUNITY COST
SECOND, WHO’S TO SAY THAT I WON’T RUN OFF WITH YOUR MONEY, OR GET
HIT BY A BUS
SO NOT ONLY MUST WE CONSIDER OPPORTUNITY COSTS, WE MUST ALSO
CONSIDER RISKS
IN OTHER WORDS, FUTURE PROMISED MONEY HAS VALUE TODAY, BUT IT IS
NOT 1 FOR 1 VALUE
FUTURE PROMISED MONEY IS WORTH LESS THAN THE SAME MONEY RIGHT
NOW.
IN OTHER WORDS, FUTURE MONEY NEEDS TO BE DISCOUNTED
FORTUNATELY, AN ARMY OF MATHEMATICIANS WORKED THEIR
MAGIC AND CAME UP WITH A COUPLE OF NIFTY FORMULAS
INTERNAL RATE OF RETURN (IRR) AND
NET PRESENT VALUE (NPV)
(ACTUALLY, IT’S REALLY THE SAME FORMULA, JUST SOLVED FORWARDS AND BACKWARDS)
THESE FORMULAS LOOK AT YOUR FUTURE PROMISED CASH FLOWS, AND
DISCOUNT THEM FOR TODAY
(SOMETIMES WE CALL THIS DISCOUNTED CASH FLOW)
IT IS NOT ACTUALLY HARD MATH, BUT IT ISN’T EASY MATH EITHER
(UNLESS YOU ARE FROM ANYWHERE OUTSIDE OF THE US, IN WHICH CASE, IT IS EASY)
FORTUNATELY, BILL’S BOYS IN THE MS EXCEL TEAM HAVE TAKEN THAT MATH
AND TRANSFORMED IT INTO A VERY SIMPLE FORMULA IN EXCEL WHICH 7 OF
9 CHIMPANZEES CAN USE
THE FORMULA IS:
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
SO, IN ORDER TO USE MS EXCEL TO CALCULATE YOUR START-UP’S VALUE,
YOU NEED TO KNOW:
WHAT IS THE DISCOUNT RATEWHAT ARE THE FUTURE CASH FLOWS
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
GETTING FUTURE CASH FLOWS IS EASY
YOU JUST GRAB THE PROFIT (NOT REVENUE) LINE FOR YOUR NEXT 5
YEARS
(YOU GET THAT IN YOUR PRO-FORMA P&L)
(NOTE FOR ADVANCED USERS: I AM NOT A FAN OF TERMINAL VALUE FOR START-UPS, SO I WON’T COVER IT HERE. I’M ALSO NOT CONSIDERING DEBT SINCE IT IS
A START-UP. CORPORATE TREASURERS NEED TO READ SOMETHING MORE ADVANCED THAN THIS DECK, AS I’M SURE YOU REALIZED ALREADY)
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
CHOOSING THE DISCOUNT RATE HOWEVER, IS SLIGHTLY HARDER
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
(SOMETIMES PEOPLE REFER TO DISCOUNT RATE AS WEIGHTED AVERAGE COST OF CAPITAL OR WACC)
THE DISCOUNT RATE IS A NUMBER FROM 0 TO 1.
THE CLOSER TO 1 YOU GET, THE MORE YOU DISCOUNT
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
SO A DISCOUNT RATE OF .2 (20%) IS NOT VERY RISKY AT ALL, AND A
DISCOUNT RATE OF .8 (80%) IS SUPER RISKY.
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
THE DISCOUNT RATE IS ACTUALLY CALCULATED BASED ON MANY
CRITERIA
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
FOR EXAMPLE…
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
RISKHOW CONFIDENT IS THE INVESTOR
ABOUT THE LIKELIHOOD THE PROFIT YOU FORECASTED WILL ACTUALLY MATERIALIZE (REVENUE AND COST
ASSUMPTIONS ACCURATE?)
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
OPPORTUNITY COSTSHOW MUCH MONEY WOULD THE
INVESTOR MAKE IF SHE INVESTED THE MONEY ELSEWHERE – ESPECIALLY IN
RISK-FREE THINGS LIKE T-BILLS…AND WHAT ABOUT INFLATION…
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
MARKET NORMSTHE DISCOUNT RATE WILL ALSO VARY
FROM MARKET TO MARKET WHERE THE WISDOM OF CROWDS HAS GENERATED
RULES OF THUMB OVER THE YEARS
(IE: PHARMA RATES ARE DIFFERENT FROM E-COMMERCE PORTAL RATES)
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
HOWEVER, HERE IS MY PERSONAL INVESTING RULE OF THUMB,
GENERICALLY
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
PHASE DISCOUNT RATEAngel Round .8Series A .6Series B .4Mezzanine .2
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
IN OTHER WORDS, IF YOU ARE USING A DISCOUNT RATE OF 50% AT THE
IDEA STAGE, I’M JUST NOT GOING TO BITE
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
BECAUSE THERE IS JUST SO MUCH DAMN RISK THAT YOUR FORECASTS
WILL BE WRONG, OR YOU’LL DIE IN EXECUTION
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
AS I NEGOTIATE YOUR DISCOUNT RATE WITH YOU, I’D ALSO BE CONSIDERING A MOTLEY OF
FACTORS…
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
HISTORY OF STABLE GROWTH AND PROFITS
PRODUCT CYCLE POINT
SIZE MARKET SHARE
INDUSTRY
CUSTOMER BASE -DIVERSIFICATION
GROWTH POTENTIAL-TOPLINE AND BOTTOM LINE
TRENDS
COMPETITIVE POSITIONING
PRODUCT MIX
UNIQUENESS
THE VALUE OF SIMILAR COMPANIES
STRATEGY FOR CONTINUED GROWTH AND
PROFITABILITY
TIMING
SO, BY WAY OF EXAMPLE…IMAGINE A FRESH START-UP THAT EXPECTS TO
HAVE PROFIT OVER THE NEXT 5 YEARS OF -250,000, 0, 250,000,
2,000,000, & 10,000,000
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)
USING EXCEL, TODAY’S VALUE OF THIS FIRM’S
FUTURE, PROMISED PROFIT IS $623,719.
THAT MEANS, IF I INVESTED $150K TODAY, I’D GET ~25%
OF THE FIRM
(WHICH MEANS 2.5M RETURN IN YEAR 5 IF WE DISTRIBUTE THE
YEAR 5 PROFIT AND I GET MY 25%)
OK, THAT'S NPV
LET ME QUICKLY MENTION IRR AS WELL SINCE IRR IS QUITE POPULAR
THESE DAYS
AS WE MENTIONED BEFORE, INTERNAL RATE OF RETURN (IRR) IS LIKE STANDING THE NPV FORMULA
ON IT'S HEAD AND SHAKING IT UP AND DOWN
THE IRR IS THE DISCOUNT RATE THAT WOULD MAKE THE NPV ZERO
OR, IN OTHER WORDS, THE IRR IS THE RATE OF EXPECTED GROWTH
THE HIGHER THE IRR, THE BETTER THE INVESTMENT
AGAIN, BILL'S BOYS CAME TO THE RESCUE
=IRR (INVESTMENT, CASH FLOW 1, CASH FLOW 2…)
IN THIS EXAMPLE, WE ASSUME THAT WE INVEST 150K IN A START-UP. THE INVESTMENT LOSES 250K IN YEAR 1, BREAKS EVEN IN YEAR
2, MAKES 250K IN YEAR 3, 2M IN YEAR 4 AND EXITS IN YEAR 5 FOR
10M
GIVEN THIS, THE INVESTOR IRR IS 127.5%
IN OTHER WORDS, WE EXPECT THIS INVESTMENT TO GROW 127.5%.
MUCH BETTER THAN A SAVINGS ACCOUNT!
SO….UH…WHICH DO YOU USE: IRR OR NPV?
HONESTLY, IT DEPENDS ON THE AUDIENCE
USE WHATEVER THE AUDIENCE PREFERS
THAT SAID, WHILE IRR IS GREAT FOR GIANT MULTI-NATIONAL FIRMS, I PERSONALLY DON'T LIKE IT FOR
START-UPS
TO ME, IRR WORKS BEST WHEN COMPARING PROJECTS OF EQUAL
RISK OR EQUAL COST & INCOME REALIZATION
IT IS GREAT FOR A BIG FIRM TRYING TO COMPARE WHETHER TO BUILD A NEW DATA CENTER OF EXTEND THE
EXISTING ONE
BUT IMHO, IT IS NOT SO USEFUL AT COMPARING WHETHER TO INVEST IN A BIO-INFORMATICS START-UP OR A B2B
E-COMMERCE PORTAL, 2 PROJECTS WITH SIGNIFICANTLY DIFFERENT RISK
& SPEND PROFILES
THERE IS ONE LAST THING I WANT TO ADD
IN AN ACQUISITION SITUATION, RATHER THAN AN INVESTOR
SITUATION, HOPEFULLY THERE IS SYNERGY VALUE BETWEEN BUYER
AND SELLER
WHICH MEANS THAT PART OF THE VALUE OF THE DEAL IS NOT JUST
YOUR FUTURE REVENUE, BUT ALSO THE POSITIVE IMPACT ON THE
BUYER’S REVENUE AS A RESULT OF THE DEAL
WHETHER THIS CAN BE ADDED TO THE BASE VALUATION IS UP TO YOUR
NEGOTIATION SKILLS, BUT IMHO, IT SHOULD BE FACTORED IN TO BE FAIR
PART 3 YOU'RE WORTH WHAT THE
MARKET SAYS YOU'RE WORTH
THE FINAL METHOD OF VALUATION LEVERAGES THE WISDOM OF
CROWDS
SPECIFICALLY, YOUR VALUE SHOULD BE SIMILAR TO THE VALUE OF
SIMILAR FIRMS, IN SIMILAR INDUSTRIES, IN SIMILAR LIFE CYCLE
STAGES, AT THIS POINT IN TIME
BASICALLY, YOUR VALUE IS THE VALUE THAT THE INVISIBLE HAND OF
THE MARKET GIVES YOU
THE MOST COMMON WAY TO GUESTIMATE MARKET VALUE IS TO
LOOK AT COMPARABLES (SIMILAR-ISH COMPANIES TO YOURS)
AND SINCE NO COMPANY IS JUST LIKE YOURS, YOU NEED TO TAKE A BUNCH
OF DATA POINTS TO TRIANGULATE
THIS IS USUALLY DONE WITH P/E RATIO
ACTUALLY, YOU CAN SOMETIMES ALSO CONSIDER: PRICE TO BOOK RATIO, EQUITY / SALES, EQUITY / CASH FLOW, EQUITY / PAT, EQUITY / BOOK VALUE OF SHARE. BUT PE IS FAR
MORE COMMON FOR START-UPS
P/E STANDS FOR
PRICE / EARNINGS(THINK OF PRICE AS SYNONYMOUS WITH VALUATION
FOR THE MOMENT)
SO IF A FIRM’S VALUE IS 8 MILLION AND THEIR EARNINGS WERE 2
MILLION, THE P/E RATIO WOULD BE 4 SINCE
8 / 2 = 4
WE REFER TO THE VALUE OF 4 AS “THE MULTIPLE”
TO GET A VALUE FOR YOU, WE NEED TO USE THE AVERAGE MULTIPLE ACROSS ALL THE COMPARABLE
FIRMS WHO HAVE BEEN VALUED.
LET’S ASSUME FOR NOW, THAT THE AVERAGE MULTIPLE TURNED OUT TO
BE 4
WITH THE MULTIPLE AND YOUR PROFIT THIS YEAR, WE CAN REVERSE CALCULATE YOUR PRICE (VALUATION)
IF THE MULTIPLE IS 4AND YOUR PROFIT WAS 500K, THEN
YOUR VALUATION IS 2 MILLION
PRICE / EARNINGS = MULTIPLEPRICE = MULTIPLE X EARNINGS
2M = 4 X 500K
THIS MAGICAL MULTIPLE IS NOT AN ABSOLUTE NUMBER OF COURSE
THE P/E RATIO CAN CHANGE DRAMATICALLY FROM INDUSTRY TO
INDUSTRY AND IT CAN CHANGE IN THE SAME INDUSTRY OVER TIME
BECAUSE LIKE ANY WISDOM OF CROWDS, IT IS SENSITIVE TO MARKET
SENTIMENT
AND MARKET SENTIMENT IS FICKLE, IRRATIONAL, UNINFORMED, AND FULL
OF EMOTIONS
*(HEY CLASSICAL ECONOMICS…YOU CAN KISS MY A
DURING THE DOT.COM BUBBLE, I SAW TECH VALUATIONS OF 15X IN ASIA.
WHEREAS TODAY, TECH VALUATIONS ARE CLOSER TO 4X
THE VALUE OF THESE COMPANIES DID NOT CHANGE
WHAT CHANGED WAS THE HYPE SURROUNDING THE MARKET
SUMMARY
THANKS FOR READING. I TOLD YOU IT WASN’T ALL THAT HARD
HERE’S WHAT YOU NEED TO REMEMBER
THERE ARE 3 WAYS TO VALUE YOUR FIRM:
1. WHAT YOU OWN (USE ASSETS – LIABILITIES) – USED FOR LIQUIDATION
2. WHAT YOU’LL EARN IN THE FUTURE (USE NET PRESENT VALUE) – USED FOR INVESTMENT
3. WHAT THE MARKET SAYS (USE P/E RATIO) – USED FOR ACQUISITIONS
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