Company Valuation and Metrics – top down or bottom up?

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Company Valuation and Metrics – top down or bottom up?

  1. 1. Jeremy  Halpern  @startupboston   Partner,  Nutter  McClennen  &  Fish   Paulina  Hill  @paulinahill   Polaris  Partners   Christopher  Mirabile  @cmirabile   Launchpad  Venture  Group   TCN  FastTrack  –  May  2014   Valuing  an  Early  Stage  Company   #TCNLive  
  2. 2. Sources  of  early-­‐stage  capital   •  Bootstrapping   –  Founder’s  capital  and  credit  cards,  bank  lines  of  credit,  loans  (SBA)   •  Equity  Financing  (Early)   –  Friends  and  family,  crowdfunding,  individual  angels,  organized  angel   groups,  early  stage  venture  capitalists   •  Equity  Financing  (Early  to  Later)   –  Venture  capitalists,  corporate  venture  funds,  private  equity  firms,   hedge  funds,  and  ultimately  the  public  markets   2  #TCNlive  
  3. 3. Investment  Size   Investment   “Cost”   Traditional  VC   Micro  VC   Equipment  Financing   Angel  Groups  Angels   AngelList   Corporate  /  Strategic   Venture   Customers   Portal  Funding   Vendors   Founder   Friends  &  Family   Crowdfunding   Grants   Venture   Debt  Bank   Loans   Personal   Loans   Private  Equity   Sources  of  early-­‐stage  capital  –  Cost:Size   #TCNlive  
  4. 4. Avoid  the  “Capital  Gap”   Stage Pre-­‐ Seed Seed   Start-­‐Up $500,000  to   $2,500,000 Early Later Source Founders,   Friends   and  Family Individual   Angels,   MicroCaps   Accelerators   Venture  Funds Investment   $25,000  to   $100,000 $100,000  to   $500,000   $5,000,000  and  up   (initial  capital  may  be  smaller,   but  exit  targets  higher) Market  Entry  Micro  Cap  VCs,   Angel  Groups  and   Angel  Group   Syndication 4   Mind  the  Gap  !   #TCNlive  
  5. 5. •  Common  Equity   –  Typical  for  Founders   –  Not  typical  for  new,  sophisticated  investors   –  Restricted  stock  and  Options   •  Debt  and  Convertible  Notes   –  Often  used  by  early  stage  companies  to  avoid  valuation   –  Not  the  best  mechanism  for  aligning  Founders  and  investors   •  Preferred  Equity     –  Primary  mechanism  for  sophisticated  angels,  angel  groups  and  VCs   5   Equity  Investment  Vehicles  
  6. 6. Pre-­‐money    $      1,500,000      $  2,000,000      $    2,250,000      $          2,500,000      $          2,750,000      $          3,000,000      $          3,250,000      $          3,500,000     Note    $        610,717      $        610,717      $  610,717      $              610,717      $              610,717      $              610,717      $              610,717      $              610,717     Series  A    $  1,500,000      $  1,500,000      $    1,500,000      $          1,500,000      $          1,500,000      $          1,500,000      $          1,500,000      $          1,500,000     Option  Pool   (8.25%)    $      297,884      $      339,134      $359,759      $            380,384      $            401,009      $            421,634      $            442,259      $            462,884     Post-­‐money    $  3,908,601      $  4,449,851      $    4,720,476      $        4,991,101      $    5,261,726      $    5,532,351      $    5,802,976      $    6,073,601     Investor   Ownership   54%   47%   45%   42%   40%   38%   36%   35%   Management   Ownership   46%   53%   55%   58%   60%   62%   64%   65%   6   Dilution    -­‐  Valuation’s  relationship  to  Ownership  
  7. 7. Capital  Needs   Time   High  Risk   Low     Risk   Crystallize   Ideas   Demonstrate   Product   Early  Scaling   Growth   Sustained   Growth   Market  Entry   •  Raising  money  takes  place  over  and  over   again  because  different  lenders  and   investors  match  the  current  capital   amounts  and  risk  profile   Risk  vs.  Return   #TCNlive  
  8. 8. •  Understand  the  capital  needed  today,  and  the  total  capital   needed  to  get  to  milestones  (e.g.  exit!)   –  Type  of  business  (e.g.  SaaS,  Medical  Equipment)?   –  Cost  of  getting  to  market?   –  Cost  of  ramping  and  running  the  business?   •  Compensate  the  management  for  getting  to  this  point   –  What  do  they  need  for  future  motivation?   –  How  many  more  senior  people  will  be  hired  w/  options?   •  Look  at  comparable  exits  to  understand  likely  exit  multiple   –  Don’t  forget  to  account  for  invested  capital!   •  Is  this  a  business  investors  can  afford  to  invest  in?   8   The  Long  View  –  Total  Capital  Requirements   #TCNlive  
  9. 9. •  Valuation  Based  on  Measuring….   –  Sales  (Multiple  of  revenue  –P/R)   –  Net  Income  (P/E)   –  Cash  Flow  (EBITDA  or  Free  Cash  Flow)   –  Discounted  Cash  Flow  (DCF)   –  Discounted  Future  Earnings   –  Net  Worth  or  Book  Value   –  Real  Options,  Black  Scholes,  etc.   •  NONE  OF  THESE  APPLY  TO  STARTUPS!   9   Quantitative  Methods  –  Valuing  Mature  Companies   #TCNlive  
  10. 10. Valuation  Issues   •  Market  Test  &  the  Power  of  Auction:  Leverage   •  Round  size     •  Source  (Angel,  VC,  Strategic  etc.)   •  Total  Capital  Requirements   •  Terms  vs.  Pre-­‐Money  Price   •  Impact  of  Option  Plans   •  Price  less  important  than  relationship   •  Positioning  for  future   •  Impact  of  Convertible  Debt  from  F&F   •  On  the  “Promise”  or  the  “Numbers”  but  not  both!  
  11. 11. Qualitative  &  Quantitative  Factors   •  COMPARABLES   –  Valuation  of  deals  recently   completed    in  a  similar  space   •  KEY  ASSETS  OF  THE   COMPANY     –  Management:  Commitment     Knowledge  &  Experience     –  Intellectual  Property  &   Defensibility   –  Financials  &  Time  to  Profit   –  Milestones  Achieved   –  Revenue   –  Customers  and  Feedback   –  Barriers  to  Entry   •  FINANCING  HISTORY  /  NEEDS   –  Funding  to  Date   –  Future  Funding  Needs   –  Last  Round  Post-­‐Money  Valuation   –  When  was  last  round  completed   –  Is  the  stock  option  pool  sufficient   •  SIZE  AND  GROWTH  OF   MARKET   –  Current  Size  &  Targeted  Market   •  NOT  the  Total  Available  Market   –  Growth  -­‐  CAGR   11  #TCNlive  
  12. 12. Early  Stage  Company  Valuation  Methodologies   •  Venture  Capital  Method  (used  also  by  many  angels)   –  Future  revenue  x  industry  multiple  x  pro  rata  percentage  x  IRR  =  current  value   •  Discounted  Hypothetical  Cash  Flow  /  Net  Present  Value   –  Based  on  fiction   •  Chicago  (DCF  x  probability  tiers)   –  Same  issue  as  above   •  Berkus  (finger  in  the  air)   –  Maximums  per  attribute  (max  $2.5m)   •  OTA/Payne  –  Comparison  to  average  x  weight   –  Helpful  for  biotech/cleantech   •  Risk  Factor  Method   –  Highly  subjective  –  a  more  detailed  version  of  Berkus  Method   •  Opportunity  Cost  /  Contribution  Model   –  Based  on  sweat  and  lost  alternative  revenue   •  1/3  Max  rule   –  Treats  angels  like  co-­‐founders  and  weight  cash  versus  sweat   •  Transaction  Comparables   –  Hard  to  find  like  deals;  general  market  trends  may  apply  
  13. 13. Investor-­‐Driven  Method  (aka  Venture  Math)   •  VALUATION  -­‐  Investor  Requirements   –  Return  rate  required  by  investor  (VC  driver)   –  10X  to  20X  –  what  is  it?   –  Time  Frame  –  3-­‐5-­‐7  years   –  Any  initial  ownership  goals   –  Valuation  can  be  determined  by  working  in  reverse  from  exit   valuation  assuming  hypothetical  intervening  dilution   •  VALUATION  -­‐  Investor  Internal  Dynamics   –  What  you  can  sell  to  your  syndicate  partners   –  Size  of  fund  and  time  since  fund  inception   –  Minimum  Investment  =  meaningful  percentage?   13  #TCNlive  
  14. 14. Dave  Berkus  Method   If  it  exists,  then                Add  to  Company  value   Sound  idea      $500k   Prototype      $500k   Quality  Team    $500k   Quality  Board    $500k   Initial  Sale      $500k   Valuation  Range  =    $0  -­‐  $2.5  million   14  #TCNlive  
  15. 15. Bill  Payne  Method   Factor  Weight          Rating  (100%  basis)  Comment   Management    30    125    On  board,  ex  sales   Size  of  Opportunity  25    115    Could  be  huge   Product/Service    10    110    Disruptive  platform   Sales  Channels    10        70    All  foreign   Stage  of  Business    10    125    Prototype  works   Other    15        80    All  revs  outside  US        100%    Weighted  Average  Rating  =  1.0875    Pre-­‐revenue  Multiplier  =  $1.75  million    Valuation  =  1.0875  x  $1.75  million  =  $1,903,125   15  #TCNlive  
  16. 16. Risk  Factor  Summation  Method  (same  company)   Baseline    $1.75  million     Risk  Factor              Adjustment  (-­‐$500k  to  +$500k)  Comment         Management  +$500k  Done  it  before   Stage  +$250k  Prototype  works   Funding  Risk  -­‐$250k  Int’l  mkts  tough   Regulatory  0  Unregulated  mkt   Manufacturing  +250k  Nothing  new   Sales  &  Mktg  -­‐$500k  Int’l  mkts   Competition  +$250k  Few  in  target  mkt   Technology  +$250k  Off  shelf  parts   Litigation  0  None  expected   International  -­‐$500k  All  revs  Int’l   Reputational  -­‐$250k  Int’l  issues   Exit    +$250k  Likely  early          $250k     Valuation  =  $2.0  million   16  #TCNlive  
  17. 17. Structure  to  allow  value  growth  over  time   •  Underlying  Assumption   –  All  business  is  a  risk  adjusted  cash  flow   –  Structuring  a  deal  is  “guessing”  what  the  exit  valuation  will  be   •  Valuation  is  a  “Black  Art”     –  Goal  is  to  quantify  a  qualitative  assessment,  and  then….   –  Negotiate  the  deal  so  that  everyone  feels  just  a  bit  unhappy   •  Setting  Deal  Structure   –  MUST  understand  total  capital  requirements  and  likely  capital  sources   –  Need  to  understand  option  pool  needs     –  Other  economic  terms  include:  liquidation  preference,  dividends,  anti-­‐ dilution  adjustment  and  vesting  of  founder’s  stock  and  option  pool   GOAL:  Founders,  Management,  Early  Investors  and  Later  Investors  all   have  great  risk  adjusted  returns   17  #TCNlive  
  18. 18. Angel  Round  Sizes  Remain  Steady  Over  Three-­‐Year  Period   $0.00   $0.50   $1.00   2011   2012   2013   Median  Round  Size   Mean  Round  Size   *Angel rounds include angels & angel groups only $950K $857K $931K $610K $600K $600K $M
  19. 19. •  Average  valuation  across  all  angel  deals  :   $2.45million    pre-­‐money     $350k  invested   19   Angel  Data  2013   #TCNlive  
  20. 20. 20   The  average     pre-­‐money   valuation  for  a     pre-­‐revenue   company     across  the  US     is  $2.1  million   Average  Valuations  -­‐  Wisdom  of  the  Angel  Crowd   #TCNlive  
  21. 21. TCN  FastTrack   May  2014   Valuing  an  Early  Stage  Company   Jeremy  Halpern   Nutter  McClennen  &  Fish   @startupboston jhalpern@nutter.com   617.439.2943   Paulina  Hill   Polaris  Partners   @paulinahill   Christopher  Mirabile   Launchpad  Venture  Group   @cmirabile  

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