Valuing early stage companies (Venture Fast Track)
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Part of the all day Venture Fast Track: http://www.thecapitalnetwork.org/programs/venture-fast-track/ ...

Part of the all day Venture Fast Track: http://www.thecapitalnetwork.org/programs/venture-fast-track/
Company Valuation and Metrics – top down or bottom up?

In today’s economic environment, where investors are strapped for cash and looking for the lowest risk alternatives, the already difficult task of defending your corporate valuation to Angels & VCs is nearly impossible. In this program we will discuss valuation methodologies, metrics, tactics and tips for early stage corporate valuations.

Experts:

- Josh Herzig-Marx – Founder of Incentive Targeting, Inc, acquired by Google

- Enrico Picozza – HLM Venture Partners
- Bill McCullen – Launch Capital
- Jeremy Halpern – Nutter, McClennen & Fish
-Josh Herzig-Marx

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Valuing early stage companies (Venture Fast Track) Presentation Transcript

  • 1. TCN  FastTrack  -­‐  October  2013   Valuing  an  Early  Stage  Company   Jeremy  Halpern  @startupboston   Partner,  Nutter  McClennen  &  Fish   Joshua  Herzig-­‐Marx   CoFounder,  Incentive  Targeting  (acquired  by  Google  2012)   Enrico  Picozza   HLM  Venture  Partners   Bill  McCullen   Launch  Capital   #TCNLive   #StartUpValuation  
  • 2. Jeremy  Halpern   Biography   ›  Nutter,  McClennen  &  Fish,  LLP  -­‐  Partner;  Director  of  Biz  Dev,  Emerging  Companies  Team   •  Top  10  Boston  law  firm   •  Represent  clients  in  technology,  hardware,  software,  mobile,  medical  devices,  health   IT,  biotechnology,  cleantech  CPG,  consumer  electronics,  sports  &  entertainment     •  Provide  support  and  outreach  to  the  entrepreneurial  community   ›  Boards  and  Organizations   ›  MassVentures  –  Director  &  Investment  Committee  Member   •  The  Venture  Arm  of  the  Commonwealth-­‐-­‐  catalyzing  innovation  in  Massachusetts  by   providing  seed  and  early  stage  venture  funding  to  high  growth  technology  startups.   ›  The  Capital  Network  –  Director;  Past  Chairman   •  Providing  education,  resources  and  community  to  high  growth  entrepreneurs  and   angel  investors  as  they  navigate  the  early  stage  capital  process   ›  Entrepreneurial  Experience  –  Cofounder  -­‐  MobileTek   ›  UC  Berkeley,  B.A.  (Go  Bears!);  UCLA  School  of  Law,  J.D.   ›  2012  recipient  of  The  Boston  Business  Journal’s  “40  under  40  Award”   2  
  • 3. Enrico  Picozza   Biography   ›  Current   ›  Venture  Partner  –  HLM  Venture  Partners   ›  Previous   ›  HTS  Biosystems,  Inc.,     ›  PerkinElmer,  Inc.     ›  Applied  Biosystems,  Inc.     ›  Holds  nine  patents  and  has  been     ›  Recognized  by  the  Smithsonian  Institute  for  his  achievements  in  PCR   ›  Board  observer  for  Interlace  Medical   ›  Master’s  degree  in  molecular  and  cell  biology  from  the  University  of  Connecticut.   3  
  • 4. Bill  McCullen   Biography   ›  Current   ›  Director,    LaunchCapital   ›  Over  7  years  backing  companies  in  the  networking,  semiconductor,  clean  energy  and  online   markets.   ›  Previous   ›  Sycamore  Networks   ›  Windspeed  Access  Systems   ›  Continuum  Photonics   ›  Mintera   ›  Susquehanna  Financial   ›  BS  and  MS  degrees  in  Electrical  Engineering  at  Worcester  Polytechnic  Institute     ›  MBA  from  the  MIT  Sloan  School  of  Management       4  
  • 5. Josh  Herzig-­‐Marx   Biography   ›  Currently  with  Google     ›  Co-­‐founder  of  Incentive  Targeting  which  sold  to  Google  in  2012   ›  Previously:  Client  Manager  at  SunGard  iWorks  and  Navimedix   ›  MBA  from  Babson  College   5  
  • 6. 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   6  
  • 7. Sources  of  early-­‐stage  capital  –  Cost:Size   Angel  Groups   Angels   Traditional  VC   AngelList   Micro  VC   Crowdfunding   Investment   “Cost”   Friends  &  Family   Founder   Personal   Loans   Private  Equity   Corporate  /  Strategic   Venture   Portal  Funding   Venture   Debt   Bank   Loans   Vendors   Equipment  Financing   Customers   Grants   Investment  Size  
  • 8. Avoid  the  “Capital  Gap”   Mind  the  Gap  !   Stage Pre-­‐ Seed Seed   Start-­‐Up Market  Entry Source Founders,   Friends   and  Family Individual   Angels,   MicroCaps   Accelerators    Micro  Cap  VCs,   Angel  Groups  and   Angel  Group   Syndication $25,000  to   $100,000 $100,000  to   $500,000   $500,000  to   $2,500,000 Investment   Early Later Venture  Funds $5,000,000  and  up   (initial  capital  may  be  smaller,   but  exit  targets  higher) 8  
  • 9. Equity  Investment  Vehicles   •  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   9  
  • 10. Dilution    -­‐  Valuation’s  relationship  to  Ownership   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     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      $        610,717      $  610,717      $      339,134      $359,759      $              610,717      $              610,717      $              610,717      $              610,717      $              610,717      $            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%   10  
  • 11. Risk  vs.  Return   High  Risk   •  Raising  money  takes  place  over  and  over   again  because  different  lenders  and   investors  match  the  current  capital   amounts  and  risk  profile   Capital  Needs   Low     Risk   Time   Crystallize   Ideas   Demonstrate   Product   Market  Entry   Early  Scaling   Growth   Sustained   Growth   11  
  • 12. The  Long  View  –  Total  Capital  Requirements   •  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?   12  
  • 13. Quantitative  Methods  –  Valuing  Mature  Companies   •  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!   13  
  • 14. 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!  
  • 15. 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   15  
  • 16. 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  
  • 17. 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?   17  
  • 18. 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   18  
  • 19. Bill  Payne  Method   Factor Management Size  of  Oppty Product/Service Sales  Channels Stage  of  Business Other    Weight    30      25      10      10      10      15      100%            Rating  (100%  basis)  Comment    125    On  board,  ex  sales    115    Could  be  huge    110    Disruptive  platform        70    All  foreign    125    Prototype  works        80    All  revs  outside  US    Weighted  Average  Rating  =  1.0875    Pre-­‐revenue  Multiplier  =  $1.75  million    Valuation  =  1.0875  x  $1.75  million  =  $1,903,125   19  
  • 20. Risk  Factor  Summation  Method  (same  company)   Baseline   Risk  Factor             Management Stage Funding  Risk Regulatory Manufacturing Sales  &  Mktg Competition Technology Litigation International Reputational Exit         Valuation  =  $1.75  million      Adjustment  (-­‐$500k  to  +$500k)  +$500k  +$250k  -­‐$250k  0  +250k  -­‐$500k  +$250k  +$250k  0  -­‐$500k  -­‐$250k  +$250k  $250k      $2.0  million    Comment          Done  it  before    Prototype  works    Int’l  mkts  tough    Unregulated  mkt    Nothing  new    Int’l  mkts    Few  in  target  mkt    Off  shelf  parts    None  expected    All  revs  Int’l    Int’l  issues    Likely  early   20  
  • 21. 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   21  
  • 22. Average  Valuations  -­‐  Wisdom  of  the  Angel  Crowd   The  average     pre-­‐money   valuation  for  a     pre-­‐revenue   company     across  the  US     is  $2.1  million   22  
  • 23. Contact  Info   TCN  FastTrack   October  2013   Valuing  an  Early  Stage  Company   Jeremy  Halpern   Partner   Nutter  McClennen  &  Fish   jhalpern@nutter.com   @startupboston   617.439.2943   23