Your SlideShare is downloading. ×

Early Valuation for Entrepreneurs by John Shumate

238

Published on

Early Valuation for Entrepreneurs by John Shumate …

Early Valuation for Entrepreneurs by John Shumate

John Shumate is CEO of ValuLogik and has focused his career on working closely with venture-backed companies. He has worked with hundreds of early- and growth-stage companies across many industries, many of them dealing with highly-technical products or business models. He believes strongly in the use of carefully-applied rigor to rationalize financial models, business plans, valuations, and other quantification tools. He has over a decade of financial experience, including buy-side and sell-side mergers and acquisitions; debt and equity capital raises; strategic consulting; complex financial modeling; business plan development; equity and derivative valuation; and venture incubation. John recently served as Vice President at Blue Equity, a growth-stage private equity firm, and Chief Financial Officer at BellaNovus, an early-stage medical device development company. He was a Senior Associate at bCatalyst, a business incubator and financial services provider to early-stage companies. He has also held analytical roles for Ethicon-Endo Surgery, a division of Johnson & Johnson, and Hilliard-Lyons, a regional brokerage house. John attended the Wharton School at the University of Pennsylvania, where he received a B.S. in Economics and dual concentrations in Finance and Management

Published in: Economy & Finance
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total Views
238
On Slideshare
0
From Embeds
0
Number of Embeds
1
Actions
Shares
0
Downloads
14
Comments
0
Likes
0
Embeds 0
No embeds

Report content
Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
No notes for slide

Transcript

  • 1. John Shumate Chief Executive Officer Equity Valuation Primer Focus on Early-Stage Companies
  • 2. Roadmap Page 2 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 3. Seminar Introduction Page 3 • Purpose: • Practical equity funding “rules of thumb” • Fundamental valuation methodologies • Current trends in funding • Context of early-stage companies • Perspective: • Early-stage valuation and analytics specialists • “Real world” perspective with practical focus
  • 4. Profile Page 4 John Shumate – CEO, ValuLogik ValuLogik (financial services; early-stage) BellaNovus (medical device) Blue Equity (private equity) bCatalyst (incubator) Ethicon – Johnson & Johnson (medical device) Wharton; B.S. Finance University of Pennsylvania
  • 5. Roadmap Page 5 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 6. Context: Why Are We Here? Page 6 Entrepreneurs Competitors Investors Customers Next Big Thing Analyze Value
  • 7. Focus: Equity Valuation • Variety of different property to value • Focus on Equity Valuation or deriving the valuation of a company (or some interest in that company) Page 7 Security Type Example Equity Company Fixed Income Bonds, Annuities, etc. Derivatives Stock Options Real Estate Warehouse Currencies HKD vs. USD
  • 8. Take a Step Back: Valuation Purpose • Valuation: Process to establish value for an entire or partial interest in a company, considering both quantitative and qualitative, tangible and intangible factors • Context is extremely important Page 8 Context Objective Selling Company Maximize Value IPO Float Successful “Pop” Buy-Side Analysis Minimize Price Spin Out Fair Market Value Stock Option Strikes Min (Mgmt); Mixed (Shareholders) Litigation Biased Argument Mediation Fairness Opinion
  • 9. Real World Use • Many real world applications of core valuation concepts • Just a few include: Page 9 Venture Investment Stock Options Initial Public Offering Buy-Side Acquisition Merger Sell-Side Acquisition Debt Offering Defense Analysis Fairness Opinion “Recap”Divestiture Research
  • 10. Standards of Value Page 10 Fair Market Value • Standard for most transactions • Willing buyer, willing seller Fair Value • Multiple definitions • Not as widely used Strategic/Investment Value • Value to a specific investor • Based upon individual needs • Three core standards of value • Fair Market Value (FMV) is most common standard • FMV Definition: “The price at which the property would change hands between a willing buyer and a willing seller, neither being under a compulsion to buy or sell and both having reasonable knowledge of relevant facts.”
  • 11. Distribution of Value Perspectives Page 11 • Different parties view value of the same entity differently:
  • 12. Levels of Value Page 12 • Resulting levels of value occur • Various discounts/premiums
  • 13. Keep in Mind • Two key valuation questions: 1. What is the company worth? 2. What can/will someone pay? • Art as well as science • Highly subjective in nature • Purpose, context, and surrounding conditions are key • Based upon future performance • Past performance is indicator of future performance for later stage companies • Early-stage, high-growth, and more speculative companies are forward-looking Page 13 Not Always the same
  • 14. Understanding Future Potential & Risk • Risk/Return Trade-Off • Risker investments require a higher rate of return • “What percentage return would and investor require?” Page 14 If expected return doesn’t justify added risk of moving from A to B, not worth the risk
  • 15. Core Types of Equity Investments Page 15 Common Stock Preferred Stock Participating Preferred Options Warrants
  • 16. Roadmap Page 16 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 17. High-Level Drivers • The longer it takes your forecast to get to profitability, the less you are worth now • Use comparable companies as a guide: what was a comparable company’s value at profitability? • In some instances, you are worth as much as your potential (Instagram) • Reputation is important: Jeff Bezos would get a high valuation for any startup Page 17
  • 18. Early-Stage “Rules of Thumb” • How much money do you need? • 6 months of runway / 3 experiments/studies • Investors want to see progress/growth in 18 months • Average early-stage investments/valuations by investor type: Page 18 $2,600,000 $1,500,000 $1,000,000 $400,000 $640,000 $300,000 $100,000 $20,000 Micro-VC Super Angel Angel Incubator Pre-Money Investment
  • 19. Average Funding by Round • Venture Deal data from January 2013 to May 2014 shows average funding by round: Page 19 $575,869 $6,488,214 $13,787,932 $21,508,156 $27,486,720 $50,000 $4,490,251 $10,000,000 $16,000,000 $20,000,000 Seed Series A Series B Series C Series D Mean Median
  • 20. Roadmap Page 20 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 21. Roadmap Page 21 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 22. Environmental Factors • Variety of external factors set the landscape for valuation • Each can have considerable impact Page 22 IndustryEconomy Structure Other
  • 23. Economic Impact • Numerous economic forces can influence value • Example: Increased volatility results in decreased equity values Page 23
  • 24. Industry Impact • Overall industry conditions or competitor performance can directly influence value • Example: Even when an individual company is performing well, negative industry trends can have a “drag” effect on value Page 24
  • 25. Structural Impact • Imposing capital structure can have dramatic effect on a particular class of equity • Example: Participating preferred can increase “hurdle” for common shares Page 25 Preferred Investment Available for Distribution Preferred Dividends Preferred Participation Common Sale Price
  • 26. Impact of Other External Factors • Countless other qualitative factors can relate directly to a company’s value • Example: Perceived political risk can increase market uncertainty and decrease values of companies operating in that domain Page 26
  • 27. Roadmap Page 27 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 28. Page 28 Historical Financials • Mature companies focus on past results to predict future performance • Historical Income Statements (P&L) and Balance Sheets (BS) are key for this analysis • Review: • P&L is a flow statement summarizing revenues and expenses over a period of time (perhaps a year); arriving at net income • BS is a stock statement summarizing assets and liabilities at a single point in time (perhaps at year-end); arriving at an equity differential
  • 29. Financial Projections • Problem with historical financial analysis is that it is often less meaningful for early-stage companies • Early-stage companies are often targeting dramatic future growth • Valuations must be based on future performance • Critical to have detailed projections • Many early-stage valuations will be based upon a blend of forward-looking projections and market-based comps Page 29
  • 30. Page 30 Sample Income Statement
  • 31. Page 31 Sample Balance Sheet
  • 32. Financial Ratios • Use financial ratios to examine past and future years • Ideally, key financial ratios should be compared over a period of several years in order to identify trends • Common Types • Internal Liquidity Ratios • Operating Efficiency Ratios • Operating Profitability Ratios • Business Risk (Operating) Analysis • Financial Risk (Leverage) Analysis • Capital Efficiency Ratios • Compare with comparable companies Page 32
  • 33. Roadmap Page 33 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 34. • Three core methods for equity valuation: • Must select the right method(s) of valuation for specific company and purpose • Not all valuations can be done using the same method Asset Approach Income Approach Market Approach Valuation Methodologies Page 34
  • 35. Page 35 Asset Approach • Considerations: • Difficulty in appraising value of intangible assets like trademarks, patents, goodwill, etc. • Assets are recorded at historical costs; GAAP principles were not intended to reflect current value • Only effective for liquidation scenarios • Does not value future potential Total Assets Total Liabilities Liquidation Value • Asset Approach examines static value of a company’s assets and liabilities
  • 36. Page 36 When to Use Asset Approach • Use Asset Approach when: • A company is distressed and facing liquidation • A company has developed some IP, but has no way to value it in a contextual manner; there is no business plan or “story to tell” of how it might generate future value • Asset Approach is not an appropriate approach for most early-stage companies • Example:
  • 37. Roadmap Page 37 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 38. Market Method Approaches • Market Approach examines other similar companies (“peer group”) and derives value based upon comparison • Two core sources of comparables: • Publicly-Traded companies have transactions every day on global stock exchanges • Private Transactions include larger deals (M&A, PE, etc.) Page 38 Publicly- Traded Companies Private Market Transactions
  • 39. Market Method Sources • Result is relative value based upon key multiples • Most commonly used multiples: • Enterprise Value/Revenue • Enterprise Value/EBITDA • Both publicly-trade and transaction “comps” rely on publicly available information • Public companies provide daily trading info via exchanges • Yahoo/Google Finance, Bloomberg, 10k filings • Transactional data is more difficult to come by • Subscription databases are the best way to get transactional data (Zephyr, Dealogic, Capital IQ, Factset) Page 39
  • 40. Public Guideline Companies Example Page 40 Google(GOOG) • Market Cap: $379.54B • Enterprise: 332.85B • Revenue: 62.29B • EBITDA: 18.58B • EV/Revenue 5.34x • EV/EBITDA 17.91x • Shares Out. 674.49M • Share Price $562 • Beta 1.14 Yahoo(YHOO) • Market Cap: $34.88B • Enterprise: 33.59B • Revenue: 4.67B • EBITDA: 887.3M • EV/Revenue 7.19x • EV/EBITDA 37.85x • Shares Out. 1.01B • Share Price $35 • Beta 1.12
  • 41. Transaction Comparisons Example Page 41
  • 42. Medical Devices Mobile Applications Market Method Subjectivity • Difficult to find pure comps • Large degree of subjectivity • Must “Know the Story” • Early-stage companies often don’t fit into neat buckets • Similar as possible in terms of operations, stage, and financials • Must often use a proxy mix for more complex situations • Example: New mobile app that interacts with surgical equipment to improve efficiency Page 42
  • 43. Selecting Comparables • Merger and Acquisition (M&A) Comps: • Determining the list • Similar in operations and financial aspects (use ratios) • Timing (within the last 2 years is optimal) • Similar size (preferable); can use regression as well • Circumstances around the deal • Market conditions • Public Company Comps • Similar to M&A criteria • Relevant trading multiples at a point in time Page 43
  • 44. Selecting Comparables • Typically use weighted average of selected comps • Multiply the company’s revenue or EBITDA by the appropriate comparison multiple Page 44
  • 45. Roadmap Page 45 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 46. Income Method • For most early-stage companies, the value is in the future • Income Method used when the earning capacity of the company is a factor for consideration • Determines value by converting anticipated economic benefit into a single present value • Three main approaches: Page 46 Capitalization Method Excess Earnings Method Discounted Cash Flow Method
  • 47. • Core concept: “A dollar today is worth more than a dollar tomorrow” • Present value captures value today of future cash flows: PV = 𝐶𝐹1 (1+𝑅) + 𝐶𝐹2 (1+𝑅)2 + 𝐶𝐹3 (1+𝑅)3 + … + 𝐶𝐹 𝑛 (1+𝑅) 𝑛 where CF1, CF2, … CFn equals the cash flows in period 1, 2, … n • This concept is central to all income method calculations Present Value Page 47
  • 48. Discount Rate Development • Calculating the appropriate discount rate is one of the most important steps • Two Primary Methods • Build-Up Model • Capital Assets Pricing Model (CAPM) • Build-Up Method is most intuitive Page 48
  • 49. Build-Up Method Page 49 Risk-Free Rate Equity Risk Premium Industry Risk Premium Size Risk Premium Specific Company Risk Premium Spec. Size Risk Premium Industry Risk Premium Equity Risk Premium Risk-Free Rate (U.S. Treasuries)
  • 50. Build-Up Components • Risk-Free Rate: The rate for U.S. Treasuries; the “safest investment there is”… at least conventionally • Equity Risk Premium: Premium that common stockholders require in the public marketplace over investors in long-term government bonds • Industry Risk Premium: Premium (or discount) measuring the risk of companies in a particular industry to the baseline risk of the overall market • Size Premium: Premium associated with investing in a company of a similar size (smaller companies have higher premiums) • Specific Company Risk Premium: Premium for specific company conditions (financial condition, management, ability to raise capital, etc.) Page 50
  • 51. Build-Up Method • Example: Page 51
  • 52. Average Discount Rates • Typical discount rates by stage: Page 52
  • 53. Capital Asset Pricing Model • Rarely used since you have to know the Beta, which implies the stock price is known • Can use a modified version by calculating the beta based on return on equity Page 53 Expected Return Risk Free Rate Beta Expected Market Return Risk-Free Rate
  • 54. • Converts the company’s estimated future income into a single, present value • Assumes the critical component to the value of the business is its ability to generate future earnings or cash flows • Assumes steady growth in the future • Capitalization of Earnings PV = Net Income Capitalization Rate Capitalization Rate = Discount Rate – Long-Term Growth Rate Capitalization Method Page 54
  • 55. • Example: PV = $1,000,000 (35% −10%) = $4,000,000 Capitalization Method Example Page 55
  • 56. Discounted Cash Flow Method (DCF) • Examines the present value of projected future cash flows, as well as the terminal value at the end of that stream • Based on unlevered cash flows • Present value is calculated by using a discount rate PV = 𝐶𝐹1 (1+𝑅) + 𝐶𝐹2 (1+𝑅)2 + 𝐶𝐹3 (1+𝑅)3 + … + 𝐶𝐹 𝑛 (1+𝑅) 𝑛 where CF1, CF2, … CFn equals the cash flows in period 1, 2, … n Page 56
  • 57. DCF Example • Discounted Cash Flow Example: Page 57
  • 58. Terminal Value • Value of the business beyond the projections • Two Methods: • Exit Multiple • Values a business as a multiple of a relevant operating statistic (most common for early-stage company) • Perpetuity Growth • Assumes growth of free cash flow at a constant rate Page 58
  • 59. DCF Considerations • Advantages • Flexible, adaptable analysis • Objective conclusion • Requires scrutiny of key drivers of value • Always obtainable • Disadvantages • Relies on forecast information • Based on numerous assumptions • Highly sensitive to changes in assumptions Page 59
  • 60. Excess Earning Method • Used as a last resort when no other methods are applicable • Hybrid of the asset and income approaches as it involves the determination of the portion of the earnings that may be attributed separately to the tangible and intangible assets of the company Page 60
  • 61. Roadmap Page 61 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 62. Calculating Enterprise Value • Example EV Calculation: • Adjustments for cash and long-term debt Page 62
  • 63. Roadmap Page 63 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 64. Value Allocation • Once the value of the company has been established, must allocate value to various classes of shares • Three Methods: Page 64 Current Value Method Probability Weighted Expected Returns Method Option Pricing Method
  • 65. Current Value Method • Waterfall analysis, which allocates a company’s enterprise value to each cascading level of stock, based upon liquidation preference or conversion value • Best used when: • Liquidity event is imminent • One class of equity outstanding • Inception-stage of development with no material progress on business plan; no reasonable basis for projections Page 65
  • 66. Probability Weighted Expected Returns Method • Probability Weighted Expected Returns Method (PWERM) considers multiple exit scenarios • Weighs the respective values based upon their probability of occurrence • Difficulty to apply due to the significant level of subjectivity • Example: Page 66
  • 67. Option Pricing Method • Option Pricing Method (OPM) is a method for allocating equity value between common and preferred shares • Most commonly used allocation method • Relies on Black-Scholes Model, a methodology for determining the contingent future value of stock and options • Five assumptions required 1. Underlying company value at the time of valuation 2. Strike price or the price at which the underlying stock will be purchased in the future 3. Risk free rate for the period 4. Time to expiration/likely liquidity horizon 5. The volatility of the shares Page 67
  • 68. Roadmap Page 68 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 69. Discounts to Common Shares • Discount for Lack of Control (DLOC) • Individual share is worth less if it is not part of a majority block with voting control • Both historical and industry-specific data is available • Typical DLOC is 25%-30% • Discount for Lack of Marketability (DLOM) • Individual share in private company is worth less if you cannot sell it on an exchange • Restricted stock studies and pre-IPO studies available • Typical DLOM is 30%-35% Page 69
  • 70. Roadmap Page 70 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 71. Final Calculation of Value • After the discounts have been applied, you are left with the final calculation of value for a single share of common stock • FMV is typically 30%-50% of the valuation of the preliminary common share price Page 71
  • 72. Roadmap Page 72 Introduction Context Early-Stage Funding “Rules of Thumb” Fundamental Valuation Methodologies Environment Historical & Projected Financials Asset Approach Market Approach Income Approach Enterprise Value Value Allocation Discounts Final Calculation of Value Trend Towards Convertible Debt
  • 73. Convertible Debt • Start-ups have changed to a lean business model; investors are following suit • Traditional financing is cumbersome, time consuming, and dated for early raises • Convertible debt model allow cash inflows without having valuation negotiations • Solves many of the problems with traditional financing Page 73
  • 74. How Does Convertible Debt Work? • Short-term • Converts into equity in the future • Automatically converts into shares of preferred stock at next equity round • Often converts at a discount to the price of the next round • 15% - 20% is typical discount • Typically used prior to the Series A Page 74
  • 75. Advantages to Convertible Debt • Cheap and fast due to simplified term sheets • Delays formal valuation until later round • Keeps control with the founders • Empowers angel investors in states that require lender licenses Page 75
  • 76. Next Steps • Contact Information • John’s email: jshumate@valulogik.com • Find Us on the Web • www.valulogik.com Page 76

×