valuations w/ jeff faust

Start-Up Valuations

By Jeff Faust, CVA

Director of Valuation Services

October 27

2015

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved. 2

Jeff Faust qualifications

FMV vs Investment Value

409A Overview

Overview of Valuation Methods

Sample valuation methods

Pre-revenue, pre-funding (FMV)

Pre-revenue, pre-funding (Investment Value)

Post-funding (FMV)

Profitable (FMV)

Objective of Presentation


ASL Director of Valuation Services

25 years in finance, serial entrepreneur.

20 years in Business Valuations.

Over 65 different industries.

All sizes and stages of development.

Employee Stock Ownership Plans (ESOPs), Stock Options (409A), Family Limited

Partnerships (FLPs), Buy-Sell Agreements, Estate/Gift Taxes, Mergers/Acquisitions

and Transactions, Litigation Support.

Testified in front of the Department of Labor and in several Superior Courts in the Bay

Area.

Certified Valuation Analyst (CVA) with the National Association of Certified Valuators

and Analysts (NACVA).

Instructor for the Venture Capital Academy (VCA).

Co-Founder of SaaS Company (Equity Management Software)

Jeff Faust Background


Valuation Workshop

FMV vs Investment Value


Valuation Workshop

Overview of 409A

Deferred comp IRC Section

No discounted options (ISO’s and NQSO’s must be granted at FMV)

Options granted must follow 1 of 3 valuation methods


Valuation Methods

Is there one formula for valuation?

Income *

---------- = Value

Risk

* Could be historical or projected but in all cases it is “normalized”


Valuation Methods

Most common

Income Approaches (DCF, DFE, Capitalized Earnings)

Market Approaches (Guideline, M&A and Comparable Transaction)

Asset Approaches (Book Value, Restated Net Worth)

Others used

Cost (Replacement)

Asset and Income Approaches (Excess Earnings)

Other / Start-Up Approaches (VC Method, Exit Multiples, Preferred

Rounds, Berkus Method, Scorecard Method, Cayenne Calculator,

People & Patents, Risk Factor Summation)


Valuation Preparation (Know what Stage you are in!)

Stage of Development

Stage

Abbreviated

Description Description

1 Start-up Enterprise has no product revenue and limited expense

history. Typically an incomplete management team has an

idea, plan, and possibly some initial product development.

Seed capital or first-round financing is usually provided by

friends and family, angels, or venture capital firms focusing on

early-stage enterprises. The securities issued to those

investors are occasionally in the form of common stock but are

more commonly in the form of preferred stock.

2 Development Enterprise has no product revenue but substantive expense

history. Product development is underway and business

challenges are thought to be understood. Typically, a second

or third round of financing occurs during this stage. Investors

are usually venture capital firms which may provide additional

management or board of directors’ expertise. Securities

issued are typically in the form of preferred stock.

3 Alpha/Beta Enterprise has made significant progress in product

development; key development milestones have been met

(e.g. hiring of the core management team); and product

development is near completion (e.g. alpha and beta testing

of the product, service, web site). Third party revenue is

beginning, although there may have been progress/milestone

payments from strategic business partners. Later rounds of

financing occur during this stage. Typical investors are venture

capital firms and strategic business partners. The typical

securities issued to those investors are in the form of

preferred stock.

4 Early Revenue Enterprise has met additional key development milestones

(e.g. growing customer orders and revenue shipments). It

has a sufficient customer base to support ongoing operations,

but is still operating at a loss. A manufacturing and

distribution plan is being implemented Typically, mezzanine

rounds of financing occur during this stage. Discussions

frequently start with potential acquirers or investment banks

for an initial public offering (IPO).

5 Positive Cash

Flow

Enterprise has a history of product revenues, and has recently

achieved breakthrough measures of financial success, such as

operating profitability or positive cash flows. Regulatory

approvals (e.g. Food and Drug Administration) have been

obtained. A liquidity event, such as an IPO or a sale of the

enterprise, could occur late this stage.

6 IPO Enterprise has an established financial history of profitable

operations and generation of positive cash flows. It is a

mature candidate for acquisition or an IPO. The form of

securities issued is typically all common stock, with any

outstanding preferred converting to common upon an IPO

(and perhaps also upon other liquidity events).

Stage

Abbreviated

Description Description

1 Start-up Enterprise has no product revenue and limited expense

history. Typically an incomplete management team has an

idea, plan, and possibly some initial product development.

Seed capital or first-round financing is usually provided by

friends and family, angels, or venture capital firms focusing on

early-stage enterprises. The securities issued to those

investors are occasionally in the form of common stock but are

more commonly in the form of preferred stock.

2 Development Enterprise has no product revenue but substantive expense

history. Product development is underway and business

challenges are thought to be understood. Typically, a second

or third round of financing occurs during this stage. Investors

are usually venture capital firms which may provide additional

management or board of directors’ expertise. Securities

issued are typically in the form of preferred stock.

3 Alpha/Beta Enterprise has made significant progress in product

development; key development milestones have been met

(e.g. hiring of the core management team); and product

development is near completion (e.g. alpha and beta testing

of the product, service, web site). Third party revenue is

beginning, although there may have been progress/milestone

payments from strategic business partners. Later rounds of

financing occur during this stage. Typical investors are venture

capital firms and strategic business partners. The typical

securities issued to those investors are in the form of

preferred stock.

4 Early Revenue Enterprise has met additional key development milestones

(e.g. growing customer orders and revenue shipments). It

has a sufficient customer base to support ongoing operations,

but is still operating at a loss. A manufacturing and

distribution plan is being implemented Typically, mezzanine

rounds of financing occur during this stage. Discussions

frequently start with potential acquirers or investment banks

for an initial public offering (IPO).

5 Positive Cash

Flow

Enterprise has a history of product revenues, and has recently

achieved breakthrough measures of financial success, such as

operating profitability or positive cash flows. Regulatory

approvals (e.g. Food and Drug Administration) have been

obtained. A liquidity event, such as an IPO or a sale of the

enterprise, could occur late this stage.

6 IPO Enterprise has an established financial history of profitable

operations and generation of positive cash flows. It is a

mature candidate for acquisition or an IPO. The form of

securities issued is typically all common stock, with any

outstanding preferred converting to common upon an IPO

(and perhaps also upon other liquidity events).


Risk Discounts – Ranges for Start-Ups

Stage of

Development Characteristics

Frei & Leleux

Life Sciences

Study (1)

Seiffer

Software

Study (2)

Plummer

Study (3)

Scherlis and

Sahlman

Study (4)

Sahlman,

Stevenson

and Bhide

Study(5)

Start-up Pre-prototype 70% - 100% 60% - 80% 50% - 70% 50% - 70% 50% - 100%

Early development Pre-commercialization 50% - 70% 50% - 60% 40% - 60% 40% - 60% 40%-60%

First Stage Commercialization 40% - 60% 40% - 50% NA NA NA

Expansion Shipping Product 35% - 50% 30% - 40% 35% - 50% 30% - 50% 30%-40%

Mezzanine/ IPO Profitable 25% - 40% 25% - 30% 25% - 35% 20% - 35% 20%-30%

(1) Frei, P. & Leleux, B. Valuating the Company. Starting a Business in the Life Sciences- from Idea to Market. (Luessen, H. (ed.).) 42-55 (Edition Cantor Verlag,

Aulendorf, Germany, 2003).

(2) John Seiffer, "The Business of Software: The Venture Capital Rate of Return". < http://discuss.joelonsoftware.com/default.asp?biz.5.254929.9> (21 November

2005) (3) Plummer, James L., QED Report on Venture Capital Financial Analysis, Palo Alto: QED Research, Inc., 1987

(4) Scherlis, Daniel R. and Sahlman, William A., "A Method for Valuing High-Risk, Long Term, Investments: The Venture Capital Method," Harvard Business School

Teaching Note 9-288-006, Boston: Harvard Business School Publishing, 1989

(5) Sahlman, William A. and Howard H. Stevenson, Amar V. Bhide, “Financing Entrepreneurial Ventures”, Business Fundamental Series, Boston: Harvard Business

School publishing, 1998.

Valuation Preparation (What discount range is appropriate)


Sample Valuation Methods

Cost Approach

Est Repl Cost (low) Est Repl Cost (high)

Current Expenses $400,000 $400,000

Services In Lieu $200,000 $400,000

Estimated Replacement Cost $600,000 $800,000

Equity Value $600,000 $800,000

Shares Issued 12,000,000 12,000,000

Stock Option Pool 3,000,000 3,000,000

Fully Diluted Shares 15,000,000 15,000,000

Price / Share $0.040 $0.053

$0.05

Pre-Revenue, Pre-Funding (FMV)



Funding

Pre-Revenue, Pre-Funding (Investment Value)

Pre and Post Money Illustrations (value continuation)

A Round B Round

Pre Money Valuation 4,000,000$ Pre Money Valuation 5,000,000$

Pre A Shares 15,000,000 Pre B Shares 18,750,000

Px/Share of Preferred A 0.27$ Px/Share of Preferred B ** 0.27$

Money Raised 1,000,000$ Money Raised 1,250,000$

Share Issued for A 3,750,000 20% Share Issued for B 4,687,500 20%

Post A Shares 18,750,000 Post B Shares 23,437,500

Post Money Valuation 5,000,000$ Post Money Valuation 6,250,000$

** Although the price per share is the same, the Post Money Valuation is clearly higher after the B Round



Funding

Pre-Revenue, Pre-Funding (Investment Value)

Pre and Post Money Illustrations (value increase)

A Round B Round

Pre Money Valuation 4,000,000$ Pre Money Valuation 10,000,000$

Pre A Shares 15,000,000 Pre B Shares 18,750,000

Px/Share of Preferred A 0.27$ Px/Share of Preferred B 0.53$

Money Raised 1,000,000$ Money Raised 2,500,000$

Share Issued for A 3,750,000 20% Share Issued for B 4,687,500 20%

Post A Shares 18,750,000 Post B Shares 23,437,500

Post Money Valuation 5,000,000$ Post Money Valuation 12,500,000$


How do preferred terms impact value?

CVM – The Effect of Different Capital Structures

Company 1 Company 2 Company 3

(No Preferred) (Non-Participating) (Full Participation)

Assumptions

Value $12,000,000 $12,000,000 $12,000,000

Common Shares Outstanding 12,000,000 12,000,000 12,000,000

Preferred Shares Outstanding 4,000,000 4,000,000

(Assume Liquidation Preference is $1/share)

Share Calculation

Value $12,000,000 $12,000,000 $12,000,000

Less: Liquidation Preference $0 $4,000,000 $4,000,000

Equals: Remaining Amount $12,000,000 $8,000,000 $8,000,000

Divided by: Shares 12,000,000 12,000,000 16,000,000

Equals: Price Per Share $1.00 $0.67 $0.50


VC Method

(Pre-)Revenue, (Pre-)Funding (Investment Value)


Year 1 Year 2 Year 3 Year 4 Year 5

Revenue Projections 1,000,000 5,000,000 20,000,000 50,000,000

Which year will you be profitable? 4

What is your Peer Group Multiple? 3 (Software = 2-3, SaaS = 4-6, Cloud = 5-8, Data = 8-12, Social = 10+)

Percent of Projections 50%

Implied Future Valuation 30,000,000

Enter discount rate (stage chart) 90%

Estimated Funding Valuation 2,300,000



VC Method – Multiples (Peer Group) ($US in millions)

Market Value of Invested Capital (MVIC) as a Multiple of:

TTM TTM TTM NFY

Revenue EBITDA EBIT Revenue

2.7 x 9.2 x 12.7 x 2.5 x

2.4 x 8.6 x 10.4 x 2.3 x

4.2 x 16.5 x 17.9 x 3.8 x

5.6 x NM NM 3.0 x

16.9 x NM NM 10.6 x

3.6 x 16.1 x 19.7 x 3.3 x

Maximum 16.9 x 16.5 x 19.7 x 10.6 x

Third Quartile 5.3 x 16.2 x 18.3 x 3.7 x

Average 5.9 x 12.6 x 15.2 x 4.3 x

Median 3.9 x 12.7 x 15.3 x 3.2 x

First Quartile 2.9 x 9.1 x 12.1 x 2.7 x

Minimum 2.4 x 8.6 x 10.4 x 2.3 x

Harmonic Mean 3.9 x 11.5 x 14.2 x 3.3 x

Coefficient of Variance 94% 34% 29% 74%

Selected Multiples 2.9 x 9.1 x 12.1 x 2.7 x

Sample Company's Financials 5.200$ (9.562)$ (10.562)$ 15.265$

Indicated MVIC Value Range 15.080 (87.014) (127.800) 41.216

Weighting 0% 0% 0% 100%

Implied Market Value of Invested Capital 41.200$

Less: Debt 10.500

Total Equity Value (Non-controlling, Marketable) 30.700$

Less: Discount for Lack of Marketability 35.0% 10.745

Total Equity Value (Non-controlling, Non-marketable) 19.955$

Perrigo Co.

Zalicus Inc.

Company Name

Abbott Laboratories

Baxter International Inc.

Mead Johnson Nutrition Company

Amicus Therapeutics, Inc.

(Pre-)Revenue, (Pre-)Funding (Investment Value)



Scorecard Method

Two-Step

(1) determine average pre-money of companies like yours

(2) compare target to perception of similar deals Strength of Management Team 0-30%

Size of the Opportunity 0-25%

Product/Technology 0-15%

Competitive Environment 0-10%

Marketing/Sales Channels/Partnerships 0-10%

Need for Additional Investment 0-5%

Other 0-5%

--------

100%

Early Stage (Investment Value)



Scorecard Method

Software Company

A company has an above average product and technology (125% of

norm), an average management team (100% of norm) and a large

market opportunity (150% of norm). The company can get to

positive cash flow with two rounds of angel investment (80% of

norm). Looking at the strength of competition in the market, the

target is average (100%) but early customer feedback on the product

is excellent (Other = 100%). The company needs some additional

work on building sales channels and partnerships (75%).




Scorecard Method


COMPARISON

FACTOR RANGE

TARGET COMPANY

FACTOR

Strength of

Management Team 30% 100% 0.3000

Size of Opportunity 25% 150% 0.3750

Product/Technology 15% 125% 0.1875

Competitive

Environment 10% 100% 0.1000

Marketing/Sales/ Partnerships

10% 75% 0.0750

Need for Additional

Investment 5% 80% 0.0400

Other factors 5% 100% 0.0500

Sum: 1.1275

Assuming the average pre-money valuation is $2.7

million, we multiply that figure with the Sum of

Factors (1.1275 x $2.7 million). Therefore, we arrive

at a pre-money valuation of $3.04 million.



Berkus Method

Developed by Dave Berkus of Tech Coast Angels


Characteristic Add to Pre-money Valuation

Quality Management Team 0 - $500,000

Sound Idea 0 - $500,000

Working Prototype 0 - $500,000

Quality Board of Directors 0 - $500,000

Product Rollout or Sales 0 - $500,000



Berkus Method


Characteristic Add to Pre-money

Valuation Target Company

Quality Management

Team 0 - $500,000 $375,000

Sound Idea 0 - $500,000 $425,000

Working Prototype 0 - $500,000 $500,000

Quality Board of

Directors 0 - $500,000 $375,000

Product Rollout or

Sales 0 - $500,000 $375,000

TOTAL 0 - $2,500,000 $2,050,000



People and Patents

Each patent and engineers is ~$1M




Risk Factor Summation

Series of Questions

Management, State of the business, Legislation/Political risk, Manufacturing risk,

Sales and marketing risk, Funding/capital risk, Competition risk, Technology risk,

Litigation risk, International risk, Reputation risk, Potential lucrative exit

+2 for very positive, +1 positive, 0 neutral, -1 negative, -2

very negative

For every +1 you add $250,000 (+$500k for +2) and subtract

$250,000 for every -1 (-$500k for a -2)




Risk Factor Summation

Assume the average pre-

money valuation is $2.3 million,

and after tallying the points, the

sum is +1.

Therefore, you would add

$250,000 to the $2.3MM

average, bringing the

company’s pre-money value to

$2.55 million.


Risk Factors Risk Rating

Management 0

State of the Business +1

Legislation/Political Risk 0

Manufacturing Risk 0

Sales and Marketing Risk -1

Funding/Capital Risk -1

Competition Risk 0

Technology Risk +1

Litigation Risk 0

International Risk 0

Reputation Risk 0

Potential Lucrative Exit +1

TOTAL =+1



Cayenne Calculator

www.caycon.com/valuation.php

Series of questions

Any Stage (Investment Value)

http://www.caycon.com/valuation.php



Summary of Values

Method Software

VC Method $2.30 Million

Scorecard $2.59 Million

Berkus $2.05 Million

Cayenne $1.84 – $2.25 Million

Risk Factor $2.55 Million



Discounted Cash Flow (DCF) – [exit multiples]

Projected Financials

FYE FYE FYE FYE FYE

12/31/12 12/31/13 12/31/14 12/31/15 12/31/16

Projected Earnings (9.238)$ (5.235)$ 1.528$ 6.859$ 10.537$

Terminal Value Calculation

Revenue Multiple 12/31/16 165.526$ 2.7

Terminal Value 430.37$

Present Value Period 1.00 2.00 3.00 4.00 5.00 5.50

Present Value Factor (3) 60.0% Discount Rate 0.624 0.390 0.244 0.152 0.095 0.075

Present Value of Debt-free Cash Flow (5.782)$ (2.042)$ 0.373$ 1.045$ 1.004$ 32.406$

Sum of Present Value of Debt-free Cash Flow in Projection Period (5.403)$

Plus: Present Value of Terminal Value 32.406

Total Equity Value (Controlling, Marketable) 27.003$

Less: Discount for Lack of Control 0.0% -

Total Equity Value (Non-controlling, Marketable) 27.003$

Less: Discount for Lack of Marketability 35.0% 9.451

Total Equity Value (Non-controlling, Non-marketable) 17.552$

Terminal

Year

Post-Funding (FMV)



Discounted Future Earnings (DFE)

Profitable (FMV and Investment Value)

Projected Financials

FYE FYE FYE FYE FYE

12/31/12 12/31/13 12/31/14 12/31/15 12/31/16

Projected Earnings 1,454,100$ 1,537,125$ 1,703,328$ 1,885,410$ 2,181,030$

Terminal Value Calculation

Gordon Growth Method 23.0% risk rate, 3.0% growth rate

Terminal Value 11,232,307$

Present Value Period 1.00 2.00 3.00 4.00 5.00 5.00

Present Value Factor 23.0% Discount Rate 0.813 0.661 0.537 0.437 0.355 0.355

Present Value of Net Income 1,181,525$ 1,015,436$ 914,822$ 823,264$ 774,265$ 3,987,467$

Sum of Present Value of Net Income in Projection Period 4,709,312$

Plus: Present Value of Terminal Value 3,987,467

Indicated Equity Value 8,696,779$

Less: Discount for Lack of Control 0.0% -

Total Equity Value (Non-Controlling, Marketable) 8,696,779$

Less: Discount for Lack of Marketability 35.0% 3,043,872

Total Equity Value (Non-Controlling, Non-marketable) 5,652,906$

Terminal

Year


Great Website Resources

https://angel.co/

http://visual.ly/vizbox/startup-universe/

(search for “Startup Universe”)

https://angel.co/





Q & A

Any questions?


Jeff Faust, CVA

[email protected]

(408) 377-8700 x232

Contact Information

Abbott Stringham & Lynch

1550 Leigh Avenue

San Jose, CA 95125

(408) 377-8700

valuations w/ jeff faust

Education