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Valuation of early stage companies

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A presentation by Andreas Schulze of Marsa Corporate finance to the DayOne Accelerator discussing valuation of early stage companies.
If you would like a copy for download, please contact andreas.schulze@marsaco.com

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Valuation of early stage companies

  1. 1. Marsa Corporate Finance GmbH, Basel Switzerland Valuation Approaches for Early- stage Companies Strictly private andconfidential May 2019 An Overview of Methods to baselarea.swiss DayOne Accelerator, 21.05.2019
  2. 2. 1 Introduction and Valuation Thoughts 2 Challenges, Survival Rates 3 Terminology, Input, Modelling 4 Valuation Methods 4.1 Valuation Method 1 - Assets and IPApproach 4.2 Valuation Method 2 – Peer, Multiples, Deals 4.3 Valuation Method 3 - DCF 4.4 Valuation Method 4 - rNPV 4.5 Valuation Method 5 - ROV 4.6 Valuation Method 6 – VC Methods 5 VC Valuation Methods 6 Contact 7 Appendix Valuation of early-stage companies - Marsa Corporate Finance GmbH May 2019 2 Contents
  3. 3. The valuation of early stage companies is a central matter to both investors and founders. Valuation of early-stage companies is a challenge due to - lack of historical data - little or no revenues - operating losses - range of uncertain factors Depending on the intended use and purpose a wide range of methodologies may be selected. Each has its own pro’s and cons. A single method may not give the most relevant valuation. Select the most appropriate ones. 1 Introduction and InvestmentThoughts Introduction and Valuation Thoughts Valuation of early-stage companies - Marsa Corporate Finance GmbH May 2019 3
  4. 4. 1. Early stage company evaluations might not only depend on firm characteristics, but also on those of the investors: ◦ Density of the VC market ◦ Level of networking ◦ VCs' reputation and size of investments and follow-on rounds ◦ Market conditions and interest in specific industry/therapeutic area/technology ◦ Alternative investors (business angels, HNWI*,…) 2. Information asymmetry becomes critical: ◦ Evaluation of companies based on the information provided by the founders or publicly available (may not give a comprehensive overview) 3. Characteristics of a company the investors take into consideration ◦ entrepreneur and management team experience, training, social skills ◦ Potential exit routes ◦ Commercial potential: adoption, product status, protectability (IP), customer engagement, route to market, market potential, relevant experience and financial model 1 Introduction and InvestmentThoughts Valuation of early-stage companies - Marsa Corporate Finance GmbH May 2019 4 Introduction and Valuation Thoughts
  5. 5. Young companies are diverse but they share common characteristics: • No history • Small or no revenues, operating losses, little operating details • Dependency on private equity. (founder’s savings, fff, venture capital as source of equity capital) • Investors’ multiple claims on equity. First claims on cash flows, liquidation preferences, etc. • Illiquidity of investment. More illiquid than publicly quoted companies. • Low survival rate. Most young companies don’t survive the test of commercial success and fail. Challenges in valuating young companies 2 Challenges May 2019 5 Valuation of early-stage companies - Marsa Corporate Finance GmbH
  6. 6. Young companies survival rates 2 Survival rates 20 10 0 30 40 50 60 70 80 90 100 5 15 20 Percentageofcompaniessurviving 10 Number of years of survival since starting Survival rates of US companies, by year started and number of years since start (1994-2015) Source: US Bureau of Labor Statistics, http://www.bls.gov/bdm/entrepreneurship/entrepreneurship.htm 50% 35% 20% May 2019 6 Valuation of early-stage companies - Marsa Corporate Finance GmbH
  7. 7. Terminology 3 Terminology Valuation … must fit within risk/reward expectations. Typically, early-stage pre-money valuations is well below CHF 3.0m. Company having revenues, issued patents and demonstrated growth may reach pre-money valuation higher than CHF 2.0m. Full-dilution … all commitments to issue shares, which is called the „fully-diluted“ number of shares taken into account. Fully-diluted number of shares includes all shares that company would issue if all unconditional and contingent commitments to issue shares were to be given effect (e.g., exercise of options and warrants, conversion of preferred shares, exchange of debt for equity, key management slots and for other employee stock options (ESOP). Pre-money valuation ….is the value put on a company before getting the (investors) capital. multiply the fully-diluted shares prior to the proposed financing (e.g., 2.0 m fully-diluted shares) by the price/share of the proposed financing (e.g., CHF. 1.00/share); pre-money valuation (CHF. 2.0m). Adding the financing amount (e.g., CHF 500K) to pre-money valuation gets the post-money valuation (CHF 2.5m). Pre-money valuation based on percent of company ….e.g., 20% of the company for some amount (e.g., CHF 500K) of financing. Divide the financing (CHF 500K) by the offered percentage (20%) to get the post-money valuation (CHF 2.5 m), and subtract the money (CHF 500K) from post-money (CHF 2.5 m) to get the pre-money valuation (CHF 2.0 m). Investment value vs. company valuation early stage investors will likely have their equity interest in a company diluted by later investors. E.g. angel invest CHF 500k at pre- money valuation CHF 1.0 m (owning 33%), then a venture capital firm invests CHF5.0 m the following year at CHF 5.0 m pre- money valuation, angel will now own only half as much of the company, even though the company value has increased more than three-fold. As a result, an early-stage company should know that angel generally receive 20-40% of the company’s fully diluted equity in exchange for their investment. May 2019 7 Valuation of early-stage companies - Marsa Corporate Finance GmbH
  8. 8. Terminology 3 Terminology NPV • Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows. • NPV is used in capital budgeting to analyze the profitability of a projected investment or project. Discounted Cash Flows • Future, expected cash flows from a project or venture that have been adjusted to arrive at their present value. • One uses the calculation of discounted cash flows to determine whether a particular investment is likely to be profitable. Real options valuation • Real Options Valuation, also termed real options analysis, (ROV or ROA) applies option valuation techniques to capital budgeting decisions. • A real option itself, is the right — but not the obligation — to undertake certain business initiatives, such as deferring, abandoning, expanding, staging, or contracting a capital investment project. For example, the opportunity to invest in the expansion of a firm's factory, or alternatively to sell the factory, is a real call or put option, respectively. • Rather complex model and therefore not often used. Internal Rate Of Return - IRR • Internal rate of return (IRR) is a metric used in capital budgeting measuring the profitability of potential investments. • Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero 0. • IRR calculations rely on the same formula as NPV does. May 2019 8 Valuation of early-stage companies - Marsa Corporate Finance GmbH DCF valuation: >90% of the value comes from terminal value, which is heavily dependent on many assumptions
  9. 9. Starting Points: • Financial forecast • Benchmark pricing • Sales assumptions and forecasts • Development costs • Business plan including Financial plan (project-based) Input - Financial modelling 3 Input – Financial Modelling May 2019 9 Valuation of early-stage companies - Marsa Corporate Finance GmbH
  10. 10. Valuation methods - Overview 4 ValuationMethods 1 2 3 4 5 Fair market value on all physical assets (office space & furniture, tools, inventory, prototypes) and Value of patents. Project and Asset Approach Peer Group Multiples Deals DCF rNPV Real Option Model Comparable early stage companies who have received financing. Similar companies taken over & use multiples Discounted cashflows as measure of attractiveness of business Risk adjusted NPVs Relatively complex and challenging to employ May 2019 10 Valuation of early-stage companies - Marsa Corporate Finance GmbH
  11. 11. Fair market value on all physical assets (office space, furniture, tools, inventory, prototypes Definition of Fair market value: ...is the highest price an asset would sell for in the open, free market where buyer and seller are knowledgeable, motivated to sell and no pressure is applied to either. Method: 1. Examine the item to be valued and note any special characteristics 2. Find at least 3 of nearly identical items that have recently sold. Consider likeness, physical condition, age, history 3. Average the previous sales prices 4. Adjust for any unique element of the item to be valued that cannot be found in similar item (damage, options,…) 5. Consider value of patent. How to compute the value of a patent? Valuation method 1 – Assets and IP approach 4.1 Valuation Method 1 - Assets and IPApproach May 2019 11 Valuation of early-stage companies - Marsa Corporate Finance GmbH
  12. 12. Compute the value of a Patent Valuation method 1 – Assets and IP approach 4.1 Valuation Method 1 - Assets and IPApproach Consider the patent Project development Forecast other Compute Free Cash Flow Historical Compute adiscount Compute the life (20 years) costs expenses specifically FCF success rates inthe rate (which isthe valuation (rNPV– Potential revenues linked to thepatent same therapeutic WACC – weighted risk-adjusted net (sales forecasts) use (marketing, area average cost of present value) admin, capex, capital) depreciation,…) 721 63 54 May 2019 12 Valuation of early-stage companies - Marsa Corporate Finance GmbH
  13. 13. Valuation method 2 – Peer Group / Multiples / Deals 4.2 Valuation Method 2 Young companies may be compared by some or more of the following characteristics: • Current Assets, projects, products • Stage of development • History of funding • Financial key figures such as Turnover, EBIT, Turnover/employee, etc May 2019 13 Valuation of early-stage companies - Marsa Corporate Finance GmbH (multiples xlsx – pls inquire)
  14. 14. Target Bidder Value (USD) Reasoning, Fit Date Jade Therapeutics (US) EyeGate Pharma (US) 5m Jade Therapeutics develops locally administered, polymer-based products designed to treat poorly- served ophthalmic indications March 2016 Clermont Pharmaceuticals (US) Laboratoires Thea SAS (France) 7m Clermont Pharmaceuticals engages in the drug development related to ophthalmology March 2016 Foresight Biotherapeutics (US) Shire (Ireland) 300m Foresight Biotherapeutics focuses on ophthalmic and otolaryngic drug development August 2015 Vision Eye Institute Limited (Australia) Pulse HealthLimited (Australia) 134m Vision Eye Institute Limited is a provider of ophthalmic medical and surgical care July 2015 Aciex Therapeutics (US) NicOx (France) 116m Aciex Therapeutics is an ophthalmic pharmaceutical company focused on developing first-in-class products to treat ocular diseases July 2014 Novagali Pharma (France) SantenPharmaceuticals (Japan) 120m Novagali Pharma is an ophthalmic company developing medical products used in eye therapies September 2011 Advanced Vision Research (US) Akorn (US) 26m AVR develops and markets pharmaceuticals for dry eye and external eye diseases May 2011 Valuation method 2 – (Exit)-Deals 4.3 Valuation Method 2 Source: www. May 2019 14 Valuation of early-stage companies - Marsa Corporate Finance GmbH
  15. 15. Compute the value for your company but also for the licensee and maybe continue its development. Essential to decide at which stage the project will be out-licensed. Valuation method 2 – Out-licensing 4.4 Valuation Method 2 - Out-licensing Upfront 2'000'000 Phase I Milestone 5'000'000 Phase II Milestone 8'000'000 Phase III Milestone 10'000'000 Approval Milestone 20'000'000 Reimbursement Milestone 20'000'000 Commercial Milestone USD 1b Cumulative Sales 50'000'000 Commercial Milestone USD 3b Cumulative Sales 75'000'000 Tiered royalties between 5 and20% May 2019 15 Valuation of early-stage companies - Marsa Corporate Finance GmbH E.g.: before the launch of Phase I, IND-ready project for development What can we expect ? E.g.: after Phase II, before launch of Phase III What can we expect (USD)? Upfront 20'000'000 Phase I Milestone 0 Phase II Milestone 0 Phase III Milestone 40'000'000 Approval Milestone 50'000'000 Reimbursement Milestone 50'000'000 Commercial Milestone USD 1b Cumulative Sales 75'000'000 Commercial Milestone USD 3b Cumulative Sales 100'000'000 Tiered royalties between 15 and30% Remember that we calculated the value today for a deal that will be executed in several years.
  16. 16. The DCF method: the most dominant in practice and the most conceptually correct. • The present value of a company is given by the capacity of generating future cash flows. • Future cash flows are discounted by the required rate of return (discount factor), which expresses the risk related to such payments. • In the most realistic way, it is the cost of capital of the company (WACC =weighted average cost of capital). • Terminal value: a company valuation should not stop at the first period of 10-15 years, but should be extended under the assumption of growth at constant and sustainable rate after the first explicit forecasted period. Valuation method 3 – DCF - discounted cashflow 4.5 Valuation Method 3-DCF May 2019 16 Valuation of early-stage companies - Marsa Corporate Finance GmbH DCF vs. NPV The total DCF of an investment is also referred to as the Net Present Value (NPV). If we break the term NPV we can see why this is the case: Net = the sum of all positive and negative cash flows Present value = discounted back to the time of the investment
  17. 17. Valuation method 3 – DCF - discounted cashflow 4.5 Valuation Method 3 -DCF Challenges: • Financial statements made available provide little relevant information in assessing the value because: - difficult to assess how well the revenues from existing assets will hold up if macro economic conditions become less favorable; - difficult to analyze how revenues would change, if the company changes its pricing policy or faces new competition; - expenses incurred to generate future growth are often mixed in with the expenses associated with generating current revenues; - loss reporting and no history on operating income, difficult to assess what future profit margins will be; • the discount rate is not easy to compute: • in a private company, securities are not traded and therefore WACC is a challenge; • equity in a young company often held by investors who are either completely invested in the company (founders) or only partially diversified (VCs). May 2019 17 Valuation of early-stage companies - Marsa Corporate Finance GmbH
  18. 18. Valuation method 3 – DCF - discounted cashflow 4.5 Valuation Method 3 -DCF Contd.: • the terminal value could account for a very large proportion of the overall value of a young company. • will the firm make it to stable growth? • when will the firm become a stable growth company? Competition analysis! In DCF valuation <90% of the value comes from terminal value, which is dependent on many assumptions. May 2019 18 Valuation of early-stage companies - Marsa Corporate Finance GmbH DCF is calculated as follows: CF = Cash Flow r = discount rate (WACC)
  19. 19. Valuation Method 4 - rNPV 4.6 Valuation Method 4 - rNPV May 2019 19 Valuation of early-stage companies - Marsa Corporate Finance GmbH rNPV ("risk-adjusted net present value") is a method to value risky future cash flows. rNPV modifies the standard NPV calculation of discounted cash flow (DCF) analysis by adjusting (multiplying) each cash flow by the estimated probability that it occurs (the estimated success rate). rNPV is the standard valuation method in the drug development industry, where sufficient data exists to estimate success rates for all R&D phases. How to calculate NPV:
  20. 20. Valuation Method 5 - Real Option Model 4.6 Valuation Method 5 – Real Option Model May 2019 20 Valuation of early-stage companies - Marsa Corporate Finance GmbH Real Options Valuation, also often termed real options analysis, (ROV or ROA) applies option valuation techniques to capital budgeting decisions. A real option itself, is the right — but not the obligation — to undertake certain business initiatives, such as deferring, abandoning, expanding, staging, or contracting a capital investment project. For example, the opportunity to invest in the expansion of a firm's factory, or alternatively to sell the factory, is a real call or put option, respectively
  21. 21. Valuation methods used by VCs are very often simplified (but not always). They focus on: • Top and bottom lines, without details; • Short term (3 to 5 years for valuation purposes) rather than long term; • Mixing relative valuation and DCF; • Using discount rates as a “black box” for all types of risk. • Using rNPV As an early stage company, it is mandatory to have the knowledge about methods used by VCs. But more importantly, it is necessary to compute the valuation of its own business before meeting with any of them. VC Valuation Methods 5 VC Valuation Methods May 2019 21 Valuation of early-stage companies - Marsa Corporate Finance GmbH
  22. 22. by Harvard Professor Bill Sahlman in 1987 methodologies for valuing pre-money ventures !"#$%&'( )#*'#+",- +'(." /&-%0%1'-"2345= 6),-−$)&"7 8'(.'-%)& Anticipated ROI: the multiple to expect the company will produce in return Terminal: how much to expect to sell the company for in the future Advantages: simple, easy to compute, limited information needed Drawbacks: back of the envelope valuation, lack of differentiation between industries The VC Method – Target ROI Company stage (biotechphase) Anticipated ROI (multiple) Seed (lead optimization) 20x Start-up (preclinical) 10x First stage (Phase I) 8x Second stage (Phase II) 6x Late stage (Phase III) 5x May 2019 22 Valuation of early-stage companies - Marsa Corporate Finance GmbH 5 VC Valuation Methods
  23. 23. Thank you - Your contact at Marsa Corporate Finance GmbH 8 Contact Andreas J. Schulze, CEO Marsa Corporate Finance GmbH 4010 Basel www.marsaco.com +41 76 341 18 76 andreas.schulze@marsaco.com Financing of early-stage companies Marsa Corporate Finance GmbH April 2019 23

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