Download - Valuation for Start-ups
Dr. G. Sabarinathan
Demystifying Valuation
Presentation at ForStartups
December 1, 2012
What is Value? • Some common barbs about “value”
– “Value lies in the eye of the beholder.”
– “A cynic is someone who knows the price of
everything and the value of nothing.”
• Valuation is a systematic, disciplined approach, not a
science.
• Value = Monetary estimate of the benefit from owning an
asset or the right to exploit an asset
• Useful for
• Raising Capital
• Selling /buying / merging businesses and companies
• Public floatations
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Why Care About Valuation
• Share of Wealth
• Control
Founder Ownership
Before Sharing
Founder Ownership
After Sharing
Two possible
outcomes
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
What happens when a company
issues shares to raise capital?
Demystifying Valuation ForStartups- Dr. G. Sabarinathan
Equity Dilution Illustrated
No of shares 1,000
Value of Assets 10,000
Value per share 10
Founder's share 100%
Position of HiGrow Ltd., prior to raising any external equity
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Impact of Dilution
• Let us say until the issue of the
additional 250 shares, all the shares
were held by the promoters.
• The promoters held 100% of the
equity of the company.
• This represents 100% of the control
as well as wealth of the company.
• After the dilution the promoters
share 20% of the control as well as
the wealth of the firm.
• Why would the Founder agree to
such a deal?
Pre Diln Post Diln
Founder 100% 80%
Investor 0% 20%
Total 100% 100%
Founder 1,000 1,000
Investor 0 250
Total 1,000 1,250
Value 10,000 25,000
Founder Ownership
Before Sharing
Founder Ownership
After Sharing Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Equity Dilution No of Shares
Pre Fund Post Fund
Rs/ lakhs Rs/ lakhs
Founder 1000 1000
Investor 0 250
Total 1000 1250
% Equity
Founder 100% 80%
Investor 0% 20%
Total 100% 100%
Value
Rs/ lakhs Rs/ lakhs
Founder 10,000 25,000
Investor 0 5,000
Total 10,000 30,000
• Value of the equity before funding
is Rs 10,000
• Funding causes
• Drop in founder’s share of wealth
• Increase in value of firm’s equity
• Increase in founders’ wealth
=> “Growing pie” paradigm
• Dilution is financially wise for founder
• Investor’s view is another story
• Deal will happen only if both see
financial sense in the deal, though….
• Post Money Valuation: Value of firm / equity after
funding
• Pre money Valuation: Value of equity existing at the
time of funding
• Cash: Funding Amount
• POST–MONEY = PRE-MONEY+CASH
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Neuronautica: The imaginary
case of a start-up with high
growth potential
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
The Story of Neuronautica • Founded by three neuro-psychiatrists with collective experience of forty years in
dealing with children with Selective Learning Disabilities
• Series of products lined up around FocuScience TM, the “Science of Focussing”.
• Products claimed to bring about slow transformation in the biochemistry of the
brain without the help of chemical-based pharmaceutical products.
• Collection of exercises, games and devices to help improve retentivity and
problem solving capability through improved concentration
• Target: Children in the age group of eight to fourteen years
• Non-pharma product: Does not require clinical trials or approvals
• Sourcing / manufacturing arrangements tied up
• Distribution / marketing possibilities under consideration
– Own channel of FocuZonesTM – high investment /risk / return/ model
– Distribution through toy stores, supermarkets and malls – Moderate
investments in advertisements, inventories and marketing collaterals
– Institutional marketing through schools – Low investment, low margin, low
volume model
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Stage I
Stage 2
Stage 3
0-12 months
12-24 months
18- 36 months
Stage 4
Product Development
Test Marketing
Proof of Concept
Biz Model
Management
Sales & Distribution
Economics
Activity
Risks
Cash 100 500 2000
Mkt Development
Management
Sourcing / Mfg
Biz Model
Sales & Distribution
Economics
Mkt Development
Management
Growth
Competition
Market Development
Mfg / Sourcing Stabilisation Biz Expansion Exit for Early
Investors?
Elapsed Time
Biz
Gro
wth
Neuronautica Development Roadmap and Funding Plan
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Valuation
&
Return on Investments
Two sides
of the
same coin
The centre-piece of our approach to Valuation
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
The Way Investor’s Money Multiplies
12 Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Entry
Valuation
Exit
Valuation
Grow at expected rate of return
Rs 10 crores
Investment Multiple
8 times ~ 50% CAGR
Rs 80 crores
Profit / Share 10
Price / Share
or
Investment
100
RoI
=
=
Financial data for a similar company / transaction in the market
Profit / Share 10 Price / Share
or
Investment in Target 10% Required RoI
=
=
Valuation of Target
= 10%
= 100
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Share Value 1000
Sales 500
Share Value / Re of sales =
=
Financial data for a similar company / transaction in the market
Sales 1500
10%
Estimated Share Value = =
Valuation of Target
= 2
= 3000 2
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
x Share Value / Re of sales x
Financial
Performance
Return
Expectation
Valuation
Multiple
Equity
Valuation
• Sales
• EBIDTA
• EBIT
• PAT
• Value / Sales
• Value / Profit
• Value / EBIDTA
• Value / EBIT
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Performance – Return – Valuation Nexus
Angel Funding for Neuronautica
• The Angel’s questions
– How much money does NN require?
– How will I get my investment back with a rate of return?
Liquidity mechanism?
– How long will I have to remain invested
– What is an appropriate rate of return? How do I find a
benchmark for the rate of return in terms of similarity of
• Industry
• Stage of evolution
• Other risks – Liquidity? Capital Market risks
The answers to all of these questions impact the valuation process
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Angel Investment in Neuronautica
17
Funds required Rs 100 lakhs
Angel’s expected exit 5 years after investment
Angel’s expected multiple on investment 8 times
Angel’s expected cash realisation on exit Rs 800 lakhs
Expected sales at the end of Year 5 Rs 320 lakhs
Valuation of NN at exit = Rs 320 lakhs x 10 Rs 3200 lakhs
% of exit valuation required = Rs 800 lakhs / Rs 3200 lakhs = 25%
To achieve his return objective the angel requires 25% equity for Rs 100 lakhs of cash
Valuation implicit in the transaction = Rs 100 lakhs / 25% = Rs 400 lakhs
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Angel Investment in Neuronautica
Funds required Rs 100 lakhs
Angel’s expected exit 5 years after investment
Angel’s expected multiple on investment 8 times ~ 50% RoI
Angel’s expected cash realisation on exit Rs 800 lakhs
Expected sales at the end of Year 5 Rs 320 lakhs
Valuation of NN at exit = Rs 320 lakhs x 10 Rs 3200 lakhs
% of exit valuation required = Rs 800 lakhs / Rs 3200 lakhs = 25%
To achieve his return objective the angel requires 25% equity for Rs 100 lakhs of cash
Valuation implicit in the transaction = Rs 100 lakhs / 25% = Rs 400 lakhs
……..Needless this rests on many critical assumptions
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Steps in Valuation
• Develop a sound business plan
• Be clear about all the underlying assumptions
• Incorporate the direct and indirect impact of the asset on the other
parts of the acquiring organisation
• Develop a set of forecast financials – P&L, Balance Sheet, Cash Flow
Statement
• Decide on appropriate method of valuation
• Estimate value
• Test Valuation under various scenarios
• Decide objective behind purchase – passive interest, joint venture,
strategic investment, controlling interest, as the case may be
• Add premium, if any, for achieving strategic or other objectives, such as
“control”.
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Beyond Angel Funding for Neuronautica
• On similar lines as in the angel round the company expects to raise a
Series A and Series B round of funding as indicated below
Series A
• Amount Rs 5 crores
• % equity issued 20%
• Valuation Rs 5 crores / 0.20 = Rs 25 crores
• Series B
• Amount Rs 20 crores
• % equity issued 10%
• Valuation Rs 20 crores / 0.10 = Rs 200 crores
20
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Dilution @ Neuronautica Equity-Promoters Idea
Equity
• Promoters
• Investor(s)-1
Idea
+
Cash (for Product
Development)
Equity
• Promoters
• Investor(s)-1
• Investor(s) - 2
Idea under
Development
+
Cash (for completion
+ product launch)
Equity
• Promoters
• Investor(s) - 1
• Investor(s) - 2
Business Expansion
+
Cash
RoundMoney Dilution Promoter%
Firm
Value
Promoter
Wealth
1 100 25% 75% 400 300
RoundMoney Dilution Promoter%
Firm
Value
Promoter
Wealth
1 100 25% 75% 400 300
2 500 20% 60% 2500 1500
RoundMoney Dilution Promoter%
Firm
Value
Promoter
Wealth
1 100 25% 75% 400 300
2 500 20% 60% 2500 1500
3 2000 10% 54% 20000 10800
RoundMoney Dilution Promoter%
Firm
Value
Promoter
Wealth
0 0 0 100% ? ?
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Challenges in Valuing Neuronautica • Apart from lab level evidence hardly any information on
• The effectiveness of the product in the field
• Acceptance of the product
• Challenges in sales and distribution
• Untried management team
• How far can they take this business?
• Can you find people beyond the founders’ ability?
• Will the founders agree to step aside if found necessary?
• The economics of the business under different business / operating models
• How will the investor realise his returns?
• The virtues of staged financing
• For the entrepreneur: Helps demonstrate value
• For the investor: Helps discover value / uncover risks
• The trouble with staged financing: How will the market respond when the
company needs to raise money as planned?
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Final Questions and Thoughts
1. What drives Valuation
2. How is the divergence in the outlook valuation addressed?
3. Does Valuation depend on other terms of a deal?
4. Does Valuation have to be frozen at the time of raising a
round of funding?
5. Do deals fall through on Valuation?
6. Does modelling help improve Valuation?
7. How much effort / time does one spend modelling valuation?
8. Where does one find the information required for Valuation?
9. How reliable are published information on Valuation?
10. Is it worth turning to a professional for Valuation? Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Drivers of Valuation • Environment Related
– Macro-economic outlook – Industry Outlook – Liquidity Overhang
• Firm Related – Fundamentals of the firm, esp. strategic aspects.
• Deal Related – Stage of investment and expected investment horizon – Relative size of exposure in relation to the size of the
deal. – Previous round investors’ expectations – Exit prospects and path
• Valuation Trends – Comparable deals. Caution : Compare likes. – Public market valuations and liquidity
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
25
Rejection rate, importance and reasons by stage
Initial interaction &
sharing the business
idea
‘Research’ and Short-
Listing
Business plan
presentation
Due diligence and
Negotiations
Initial stages consume over half the effort and filter-out just 76% of the deals, suggesting that there is an
opportunity to improve the efficiency of entrepreneur-investor interaction.
Effort
*
Reje
ctio
n
Rat
e**
K
ey
Reas
ons
for
reje
ctio
n
23% 29% 38% 10%
59% 17% 5%
• Interest mismatch - inappropriate vertical or geography
• Financial, marketing or sustainability related
• Communication issues • Lack of track record of the
entrepreneur • Vague or unstable plan • Bad timing – too early or
‘me-too’ offering • Not addressing a need/ non-
viable, too opportunistic, too small a market potential
• Execution doubts • Non serious entrepreneurs
walking in just to validate the idea
• Too small market size or potential
• Easily replicable plan • Closer look contrary to
initial perceptions • Lack of confidence in
management as opportunity bigger than what was proposed initially
• Lack of expectation alignment
• Competitive aspects • Unfavourable feedback on
management/ market • ‘Wildcard’ deal spoilers
52%
76%
• Poor planning – unrealistic projections
• Entrepreneur’s rigidness to modify plans as proposed by the investor
• Unable to convince about feasibility/ execution/ expansion/ sustainability
• Unrealistic demands from entrepreneur
• Lack of confidence due to inability to sustain cross-questioning
• Legal issues & other ‘wildcard events’
• Unrealistic valuation
• Too high expectations from
the management
• Lack of consensus on
governance, valuation etc
• Legal issues
• Adverse report on
management/ business
• Management’s rigidness to
accept investor’s terms
Mo
st r
easo
ns
can
be a
vo
ided
if
en
trep
ren
eu
r is
pre
-qu
alifi
ed
an
d c
oach
ed
*Effort measured as dollar value, as perceived by the respondents
**Rejection rate – of a total of 100 approaching the VC, the number rejected at this stage
14% 5%
Invest
men
t
Source: Stern Fisher-IVCA Presentation
Observations on Funding and Valuation
• Multiple rounds are not just important but inevitable for early stage, high
growth businesses Control vs Wealth Trade-off
• Multiple stages mean progressive dilution
• Successful development of investee means wealth of founders’ as well as
early round investors grows in spite of decline
– Equally, unsuccessful development could mean “washing out” of
incumbents’ wealth
• Challenges
– Anticipating requirement of funds: Too much vs Too little
– Firming up key strategic choices
– Calling capital market conditions
– Bases of Valuation
– Forecasting performance and “Incentives”
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Information on Valuation
• Public Information easily available now
– Websites of ET, Moneycontrol…
– Commercial databases: Prowess, Capitaline,
Bloomberg
• Private Information hard to come by
• Newspaper reports
• Databases like Venture Intelligence, VC Circle
• Specialised Intermediaries
– Caveat: Be careful about special terms
THANK YOU
Demystifying Valuation ForStartups - Dr. G. Sabarinathan
Agenda
• What are we valuing?
• What happens when a company issues new shares to raise
new funds?
• Financing a high growth growing start-up: A flight of
imagination
• Valuation Challenges
• How do VCs and angels carry out valuation
• Steps to Valuation
• Factors Influencing Valuation
• Closing Thoughts
29 Demystifying Valuation ForStartups - Dr. G.