How Start Ups are Valued - notes on reading

Valuing New Ventures - Notes

How do VC's, or anyone determine whether to invest in a startup.

Valuing New Ventures

• Asset Valuation – what cash flows (book value is meaningless) Profit Matters
  
• Earning Valuation – what discount rate – EPS and multiply by something, problem is what does earnings mean, many write downs, multiples used a lot, new ventures have no earnings, so nothing to multiply.
• Discounted Cash Flow – what formula –
• Value = CF1/(1+R)+CF2/(1+R)2+CF3/(1+R)3+TV3/(1+R)3

 
Stages of Venture Capital

Startup/ Concept (prd dev.) 1st round – 100% return
Expansion and mezzanine/ prototype – mkt dev. 2nd and 3rd round – 50 to 60% return
IPO/ working product and happy customers – 25 to 40% return

3 ways to get your money out of the Start Up;

Sell
Refinance
Go Public
or, stay in, why get in a business you wouldn't want to be in.

Std Rates of return                      Profit target in 5 years

25%                                          3 X INV
38%                                          5 X INV
48%                                          7 X INV
58%                                          10 X INV
100%                                        32 X INV


Don’t attract investment until you reduce the risk, stage it so you get what you need only to reduce the risk

Sources of Capital
You
Debt
Outside equity – friends and relatives, angels, venture capitalists

Investment Criteria for Venture Capitalists

• Market – growing and big. Most important to VC. Everything can be changed but not the market.
• Defendable Advantage (barriers to competitors)
• People (mgmt team)
• 5 to 7 year Financial return – clear path on how to get their money.

What VC's look for in a Management Team

• Relevant experience
• Record of success
• Highly motivated
• Equity oriented
• Intelligent
• Exceptional Intrapersonal skills

 
Adding market Value (the higher up you go, the more proof you have a valid product)

• Backlog
• Satisfied Customers
• Selling successfully
• Test marketing
• Survey concept test
• Qualitative Research
• Market analysis

 
Adding Technology Value (the higher up you go, the more proof you have a valid product)

• Use by customer
• Test by prospects
• Final design
• Prototype
• Technical feasibility
• concept

 
The key challenge is that venture capitalists (VC's) are risky to use to get money and they are expensive, so the challenge is to do what you can to reduce risk and lower the cost of money and then you still own some of the company when it is done.
 

Value = CF1/(1+R)+CF2/(1+R)2+CF3/(1+R)3+TV3/(1+R)3
R0=required return
CFn = cash flows
R = required initial return
TV3 = terminal value = CF3/(R0-G)
G = the sustained growth in cash flows

 
Factors for Risk Factor:
Market size and growth
Knockoffs
Mgmt team
Quality
Service
Saturation
Legal
Liquidity issues

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