Valuation Of Pre Revenue Companies


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A simplifed method for valuation of start-up's and pre-revenue companies

Published in: Business, Economy & Finance

Valuation Of Pre Revenue Companies

  1. 1. Valuation of Pre-Revenue Companies <ul><li>A Simplified Approach </li></ul>
  2. 2. Overall Formula <ul><li>Post-Money Terminal Value </li></ul><ul><li>= __________________ </li></ul><ul><li>Valuation Return on Investment </li></ul>
  3. 3. Overall Perspective <ul><li>No additional shares will be issued after this round of financing, so percentage of ownership will remain constant from the investment to the exit. </li></ul><ul><li>This perspective may be unrealistic, since growth companies frequently will require additional funding. </li></ul><ul><li>However, it is a useful approach for illustrating the post-money valuation concept. </li></ul>
  4. 4. Post-Money Valuation <ul><li>The valuation of the company immediately after a round of investment is closed. </li></ul><ul><li>The relationship between pre-money investment and post-money investment is: </li></ul><ul><li>Post-money valuation = </li></ul><ul><li> Pre-money valuation + New investment </li></ul>
  5. 5. Pre-Money Valuation <ul><li>The value of the company just before closing a new round of investment, including: </li></ul><ul><li>the value of the idea, </li></ul><ul><li>the intellectual property, </li></ul><ul><li>the assembled management team, </li></ul><ul><li>and the future opportunity. </li></ul>
  6. 6. Terminal Value <ul><li>The valuation of the company at exit in a future year at which time the investors ownership can be liquidated. Exits result from: </li></ul><ul><ul><li>a sale of the company via an acquisition or a merger or </li></ul></ul><ul><ul><li>an initial public offering. </li></ul></ul>
  7. 7. Estimation of Terminal Value <ul><li>Terminal value can be estimated by various techniques. </li></ul><ul><ul><li>Generally as many techniques as possible should be used to compare results. Frequently the average of multiple methods is used to estimate terminal value. </li></ul></ul><ul><ul><li>One method is through the use of industry “multiples” applied against estimated revenue or earnings before interest, taxes, depreciation and amortization (EBITDA). </li></ul></ul>
  8. 8. Examples of Terminal Value <ul><ul><li>Example 1 - If it is estimated that the company can achieve $15 million in revenue in the exit x years in the future and companies in this industry generally have a value of two times revenue, then the terminal value could be estimated at $30 million. </li></ul></ul><ul><ul><li>Example 2 – If it is estimated that the company will achieve an EBITDA of 20% of revenue (or $3 million) in the exit year and companies in this industry generally have a value of 10 times EBITDA, then the terminal value could be estimated at $30 million. </li></ul></ul>
  9. 9. Anticipated Return on Investment <ul><li>Rates of required return on investment in a seed or start-up company is generally fairly high, say 10x to 30x. </li></ul><ul><ul><li>Investors in growth companies may experience 3 to 5 times dilution between the initial investment and exit. This dilution substantially reduces the eventual return at the exit. </li></ul></ul><ul><ul><li>Very early stage investing is high-risk. In a typical portfolio of ten companies, three to five of those companies can be expected to fail, three or four will provide some return of capital or a small return on investment. </li></ul></ul>
  10. 10. Sample Math for Investment Return 10.0% Percent $2 Amount Average return per year: 7 Assumed average years invested $14 Overall return $34 $20 10 Total $30 $2 1 Company with successful exit (15x) $4 $8 4 Companies with some value remaining $0 $10 5 Companies with no value remaining Return investment Companies Category Investment Initial Number of
  11. 11. Anticipated Return on Investment <ul><ul><li>Investors should expect to achieve virtually all of their ROI from perhaps one or two companies. The few winners must be home runs, yielding 10x to 50x invested capital. </li></ul></ul><ul><ul><li>Since home runs are rare, expecting a 15x + ROI in the simplified post-money valuation calculation is justifiable to compensate for the risk and potential dilution. </li></ul></ul>
  12. 12. Application of Simplified Method <ul><li>Post-Money Terminal Value $30 million </li></ul><ul><li>= __________________ = __________ = $2 million </li></ul><ul><li>Valuation Return on Investment 15X </li></ul><ul><li>Since the post-money valuation derived as above is $2 million, if the required investment is $1.5 million, for example, the pre-money valuation would be $.5 million. </li></ul><ul><li>Higher pre-money valuations can be justified for companies that have achieved more milestones, have more experienced management teams, have more valuable intellectual property, etc. </li></ul>
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