Valuation Workshop by Anand Lunia and Shailesh V Singh 23 Jul 2011 v2


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  • The first thing to understand about VC ’s is that they’re not investing their own money. Venture capitalists start by raising money from a bunch of investors, and then distribute it to various startups. But the investors are expecting to get their money back, generally within 10 years of committing it to the fund.
  • Valuation Workshop by Anand Lunia and Shailesh V Singh 23 Jul 2011 v2

    1. 1. An Introduction To Venture Capital Anand [email_address] Shailesh [email_address]
    2. 2. Agenda Saturday, July 23 rd , 2011 <ul><li>The Billion Dollar Club? </li></ul><ul><li>What is Venture Capital? </li></ul><ul><li>Valuation Methodologies </li></ul><ul><li>Valuation in Venture Capital </li></ul><ul><li>Structuring a Fund </li></ul><ul><li>Case Study: MMT </li></ul>
    3. 3. The Billion Dollar Club
    4. 4. The Billion Dollar Club Airbnb  is  definitely in the club . The crowdsourced marketplace for turning your apartment into a hotel for a night grew  800 percent  last year in nights booked to 800,000. There are currently 60,000 listings, and bookings keep growing by 40 to 50 percent a month.  Sublets are next .
    5. 5. The Billion Dollar Club Square  is also  in the club . It is raising at least $50 million. Square passed 500,000 card readers and  1 million transactions  in May, and is processing more than  $3 million a day  in mobile payments. COO  Keith Rabois   told us at Disrupt NYC that Square will do $1 billion in transactions this year, and he thinks it could ultimately do  better financially than Paypal  (where he was an early executive). 
    6. 6. The Billion Dollar Club Dropbox , the Y Combinator file-sharing startup that only ever raised  $7.2 million  might end up with the largest valuation in the club, perhaps as high as $1.5 billion or $2 billion. It’s just growing like crazy, with  25 million users  saving 200 million files daily. That’s up from  4 million users  18 months ago.
    7. 7. The Billion Dollar Club Gilt Groupe  is already in the club. It closed a  $138 million round  at about a $1 billion valuation last May. One of the first companies to introduce online flash sales in the U.S., Gilt is on track to do $500 million in revenues this year and has expanded from fashion to  food ,  travel ,  local deals , and more.
    8. 8. The Billion Dollar Club Gilt Groupe  is already in the club. It closed a  $138 million round  at about a $1 billion valuation last May. One of the first companies to introduce online flash sales in the U.S., Gilt is on track to do $500 million in revenues this year and has expanded from fashion to  food ,  travel ,  local deals , and more.
    9. 9. The Billion Dollar Club Just above this group, is Pandora (which just went public with a  $2 billion  market cap), LivingSocial (with a  $3 billion  valuation), LinkedIn (already public, with a  $6.3 billion  market cap), Twitter (which is worth anywhere from  $3.7 billion  to  $10 billion ), Zynga (which will be worth north of  $10 billion when it goes public), Groupon (which could be worth more than  $25 billion ) and Facebook (which is already worth  $50 billion  and could go as high as $100 billion by the time it IPOs).
    10. 10. Apple
    11. 11. The Billion Dollar Club-Google
    12. 12. Multiples will change with maturity
    13. 13. What is Venture Capital?
    14. 14. Private Equity & Venture Capital <ul><li>“ Private Equity ” means capital to companies not quoted on a stock market, in exchange for an equity participation </li></ul><ul><li>Venture Capital (VC) is a sub-class of Private Equity characterized by investments made for the purpose of developing, launching, and expanding new products or service offerings </li></ul>
    15. 15. <ul><ul><ul><li>Seed Fund </li></ul></ul></ul><ul><ul><ul><li>Venture Capital </li></ul></ul></ul><ul><ul><ul><li>Buyout / Leveraged Buyout </li></ul></ul></ul><ul><ul><ul><li>Growth Capital </li></ul></ul></ul><ul><ul><ul><li>Special Situation Funds </li></ul></ul></ul><ul><ul><ul><ul><li>Stressed Asset </li></ul></ul></ul></ul><ul><ul><ul><li>Real Estate Fund </li></ul></ul></ul><ul><ul><ul><li>Infrastructure Funds </li></ul></ul></ul><ul><ul><ul><li>Secondary Funds </li></ul></ul></ul>Type of Alternative Investment Class
    16. 16. Source : Erasmic Fund Fund Raising Pattern – Life Cycle of a Startup
    17. 17. <ul><ul><ul><li>Higher returns </li></ul></ul></ul><ul><ul><ul><li>Risk capital </li></ul></ul></ul><ul><ul><ul><li>Technology driven ? </li></ul></ul></ul><ul><ul><ul><li>Capital efficiency </li></ul></ul></ul><ul><ul><ul><li>Unlisted companies / PIPE </li></ul></ul></ul>Key Attributes
    18. 18. How VC ’s work Investor Investor Investor VC fund Investor Startup Startup Startup
    19. 19. <ul><li>Fee Structure : 2 :20 model </li></ul><ul><ul><li>During commitment period </li></ul></ul><ul><ul><li>Post commitment period </li></ul></ul><ul><li>Draw down schedule </li></ul><ul><ul><li>Duration </li></ul></ul><ul><ul><li>Fund amount </li></ul></ul><ul><li>Alignment of interest </li></ul><ul><ul><li>Carry structure </li></ul></ul><ul><ul><li>Claw back provision </li></ul></ul>Deal Structure
    20. 20. Attributes of a Great VC Fund <ul><li>• Bets on people not trends </li></ul><ul><li>• Driven by the big idea </li></ul><ul><li>• Looking for a ‘Winner’ </li></ul><ul><li>• Not afraid of failure </li></ul><ul><li>• Understand how to manage a portfolio of risk </li></ul><ul><li>• Serves as a fantastic coach </li></ul><ul><li>• Does her best work outside of the board room </li></ul><ul><li>• Not waiting for validation from other VCs </li></ul>
    21. 21. In the VC’s Mind <ul><li>• Is this the right team? </li></ul><ul><li>• What’s the entrepreneur's motivation? </li></ul><ul><li>• Is this a billion dollar opportunity? </li></ul><ul><li>• Is it a game changer? </li></ul><ul><li>• How competitive is the space? </li></ul><ul><li>• How defensible is the product? </li></ul><ul><li>• How much is this thing going to take? </li></ul><ul><li>• How long to maximize value and exit? </li></ul>
    22. 22. Stages of Investment
    23. 23. Stage vs. Return
    24. 24. In the VC ’s mind <ul><li>IRR (Internal Rate of Return) </li></ul><ul><ul><li>Company ’s Current and Future Valuation </li></ul></ul><ul><ul><ul><li>Comparables (P/E,P/S,…), “Number of”, DCF, … </li></ul></ul></ul><ul><ul><li>What ’s The Best Strategy To Create Value </li></ul></ul><ul><ul><ul><li>Which are the achievable milestones and what ’s the financing needed ? </li></ul></ul></ul><ul><ul><ul><li>When is the break-even expected ? With which margins and revenues. </li></ul></ul></ul><ul><ul><li>Exit Strategy </li></ul></ul><ul><ul><ul><li>Trade sale, IPO, N th +1 round of financing, .. </li></ul></ul></ul><ul><li>Minimizing Risks </li></ul><ul><ul><li>Diluting the investment </li></ul></ul><ul><ul><li>Liquidation Preference rights </li></ul></ul>
    25. 25. Valuation Methodologies
    26. 26. Factors Captured in Valuation <ul><li>Time Value of Money – Value of dollar today vs. tomorrow </li></ul><ul><li>Risk of Cash Flows – Certainty of cash flows </li></ul><ul><li>Growth Potential of Cash flows – Future potential of business </li></ul>
    27. 27. Valuation Methodologies <ul><li>Two main valuation methodologies: </li></ul><ul><ul><li>Discounted Cash Flow Analysis (“DCF”) </li></ul></ul><ul><ul><ul><li>Current value based on internal cash flows projections </li></ul></ul></ul><ul><ul><ul><li>Adjusts for risk and time value of money </li></ul></ul></ul><ul><ul><li>Multiples </li></ul></ul><ul><ul><ul><li>Useful in comparing similar companies </li></ul></ul></ul><ul><ul><ul><li>Captures operating and financial characteristics (e.g. expected growth) in a single number that can be multiplied by some financial metric (e.g. EBITDA) to yield an enterprise or equity value </li></ul></ul></ul><ul><ul><ul><li>Expressed as a ratio </li></ul></ul></ul>
    28. 28. Discounted Cash Flow Analysis <ul><li>Current Value based on Discounting Projections </li></ul><ul><li>Key Components: </li></ul><ul><ul><li>Free Cash Flow </li></ul></ul><ul><ul><li>Terminal Value </li></ul></ul><ul><ul><li>Discount Rate </li></ul></ul><ul><li>This method works very well for businesses with stable cash flows (i.e. infrastructure, mature businesses) </li></ul><ul><li>For start-ups, however, a DCF does not work as well due to: the volatility of cash flows and difficulty it's often impossible to model revenue correctly, let alone cash flow, and terminal value </li></ul>
    29. 29. DCF Example – Company A
    30. 30. Multiples <ul><li>Multiples can be applied to a company’s financial metrics from two sources: </li></ul><ul><ul><li>Comparable Companies: </li></ul></ul><ul><ul><ul><li>Implied value in the public markets by analyzing similar companies' trading and operating metrics </li></ul></ul></ul><ul><ul><ul><li>Depends on the level of comparability of the selected publicly traded companies </li></ul></ul></ul><ul><ul><ul><li>Does not include a &quot;control premium&quot; </li></ul></ul></ul><ul><ul><li>Precedent Transaction Analysis: </li></ul></ul><ul><ul><ul><li>Multiples derived from comparable precedent M&A transactions </li></ul></ul></ul><ul><ul><ul><li>Reliability depends on the number of precedent transactions and their levels of comparability </li></ul></ul></ul><ul><ul><ul><li>Market cycles and volatility impact on historical </li></ul></ul></ul><ul><ul><ul><li>Individual buyer synergies and structure of transaction will also impact multiples </li></ul></ul></ul>
    31. 31. Commonly Used Multiples <ul><li>Price / Earnings (“P/E”) – stable services company </li></ul><ul><li>P/E/G (“PEG Ratio”) – extension of P/E; best for fast growing company </li></ul><ul><li>Price / Sales (“P/Rev”)* - brand, negative cash flows </li></ul><ul><li>Price / Book Value (“P/BV”) – banks, insurance </li></ul><ul><li>TEV / EBITDA – removes the affect of capital structure </li></ul><ul><li>* Note – in companies with debt, enterprise value is used, where equity + debt equals enterprise value </li></ul>
    32. 32. Valuation in Venture Capital
    33. 33. VCs imperative- 10X in each deal <ul><li>The “Portfolio Effect” </li></ul><ul><ul><li>Out of Ten Start-ups Funded, with Re 1 each, </li></ul></ul><ul><ul><ul><li>2 successes at 10x or better 20 </li></ul></ul></ul><ul><ul><ul><li>5 ‘OK’ returns at 1.5x to 4x 10 </li></ul></ul></ul><ul><ul><ul><li>3 write-offs, total loss of invested money 0 </li></ul></ul></ul><ul><ul><ul><li>Total Gains on Investment of Rs 10 30 </li></ul></ul></ul><ul><li>Venture Capital is fundamentally an institutionalized form of aiming for Outliers! </li></ul><ul><li>Do we know which one is 10X? We expect each one to be 10X, and then pray </li></ul>
    34. 34. Super deal - Venture Capital Perspective <ul><li>Goal - Build a highly profitable, industry dominant company to be taken public or harvested in another way at a high P/E multiple in 5-8 years. </li></ul><ul><li>Management Team - Well rounded with proven experience in building a company. Team works well together and is led by an industry star. Team must also posses high commitment and integrity. </li></ul><ul><li>Product - Proprietary product with a sustainable competitive advantage. </li></ul><ul><li>Market - Clearly identified large and growing market with minimal current and near-term competition </li></ul>
    35. 35. Valuations- What is a Fair Deal? <ul><li>Not So fair Deal </li></ul><ul><li>Current Revenue- 1 cr </li></ul><ul><li>Rev. at 5 years - 15 cr </li></ul><ul><li>Co. sold for - 60 cr </li></ul><ul><li>Investment made 2 cr </li></ul><ul><li>VC stake 60% </li></ul><ul><li>VC return 36 cr </li></ul><ul><li>VC return 18 times </li></ul><ul><li>Not So fair Deal </li></ul><ul><li>Current Revenue- 1 cr </li></ul><ul><li>Rev. at 5 years - 15 cr </li></ul><ul><li>Co. sold for - 60 cr </li></ul><ul><li>Investment made 2 cr </li></ul><ul><li>VC stake 15% </li></ul><ul><li>VC return 9 cr </li></ul><ul><li>VC return 4.5 times </li></ul>Co. grew by 15 times, VC got 18 times Co. grew by 15 times, VC got 4.5 times
    36. 36. Valuations- What is a Fair Deal? <ul><li>High sales multiple </li></ul><ul><li>Investment made 20 cr </li></ul><ul><li>Rev. at 5 years - 15 cr </li></ul><ul><li>Revenue Multiple 10 </li></ul><ul><li>Valuation 150 cr </li></ul><ul><li>VC stake 40% </li></ul><ul><li>VC return 60 cr </li></ul><ul><li>Low Sales Multiple </li></ul>VC return of 3X, not enough Again, VC return not enough Investment made 10 cr Rev. at 5 years - 30 cr Revenue Multiple 2 Valuation 60 cr VC stake 40% VC return 24 cr
    37. 37. Stake and Investment Lifecycle What do we need to optimize? Size of the circle or Promoter Stake?
    38. 38. Valuation Soft Parameters ‘ We want to raise money and hire some people and build the product. Of course, we will start with market research’ ‘ We have burnt the midnight oil for last two years to research this need, built the product and have left our jobs a few months ago because we just had to get started’
    39. 39. Valuation Soft Parameters “ We will hire a sales head as soon as we get set. We don’t mind even hiring a CEO” ‘ Here is the Sales Head, my co-founder, and I remain the CEO till the company is large enough to attract a professional ’
    40. 40. Deal Structuring
    41. 41. <ul><li>Types Of deals </li></ul><ul><ul><li>Startups </li></ul></ul><ul><ul><li>Fresh Equity – Growth Capital </li></ul></ul><ul><ul><li>Buyouts </li></ul></ul><ul><ul><li>Leveraged Buyouts </li></ul></ul><ul><li>Issues </li></ul><ul><ul><li>Performance clause </li></ul></ul><ul><ul><li>Dilution </li></ul></ul><ul><ul><li>Exit Scenario </li></ul></ul><ul><ul><li>Taxation Issues </li></ul></ul>Investment Deal Structures
    42. 42. <ul><li>Startup Structure </li></ul><ul><ul><li>Startup aims to raise ~ USD 1 Crore </li></ul></ul><ul><ul><li>Proposal </li></ul></ul><ul><ul><ul><li>VC contribution ~ INR 1 Crore for 40% stake </li></ul></ul></ul><ul><ul><ul><li>Entrepreneur ~ 60% of share for idea, execution and delivery </li></ul></ul></ul>Deal Structure
    43. 43. <ul><li>Risk faced by VC/ Investor if agreed to this this structure </li></ul><ul><ul><li>Split of proceed if venture fails </li></ul></ul><ul><ul><li>Split of proceeds if venture succeeds </li></ul></ul><ul><ul><li>Investor IRR </li></ul></ul><ul><ul><li>Good faith investment from entrepreneur : Skin in the game </li></ul></ul><ul><ul><li>Clause for staying in the venture : vesting </li></ul></ul>Deal Structure
    44. 44. <ul><li>Proposed structure from PE/ VC player </li></ul>Deal Structure Debt Investor Entrepreneur Debt INR 50,00,000 $0 Preferred Stock INR 44,00,000 Common stock $0 60 shares @ INR 10000 per share (60% stake with Investor) INR 6,00,000 - 40 shares @ INR 10,000 per shares (40% with Entrepreneur) - INR 4,00,000 1,00,00,000/- INR 4,00,000/-
    45. 45. <ul><li>ROFR : Right of first refusal </li></ul><ul><li>Tag along rights : protection of minority share holder </li></ul><ul><li>Drag along rights : </li></ul><ul><ul><li>Drag Along : majority share holder Scenario (Protection to Majority) </li></ul></ul><ul><ul><li>Drag along : minority share Scenario (Protection to Minority) </li></ul></ul>Protection Rights
    46. 46. <ul><li>Management support or back seat driving </li></ul><ul><li>Later stage valuation issues </li></ul><ul><li>Management remuneration : too much or too less </li></ul><ul><li>Performance clause : too much equity??? </li></ul><ul><li>Managing performance cycles </li></ul><ul><li>Exit points </li></ul><ul><li>Irrational exuberance </li></ul>Conflict : Post Investment
    47. 47. Case Study: MMT
    48. 48. Make My Trip Financing Rounds <ul><li>$1 million in the seed round (eVentures) </li></ul><ul><li>$10 million in Series A (SAIF partners) </li></ul><ul><li>$13 million in Series B (SAIF Partners, Helion and Sierra) </li></ul><ul><li>MMT closed Series C investment of $15 million from Tiger Fund and the three existing venture capital investors – SAIF Partners, Helion Venture Partners and Sierra Ventures </li></ul><ul><li>$70 million raised in IPO </li></ul>
    49. 49. Make My Trip Ownership