Basic start up valuation - how much r u worth

START-UP
BASIC
VALUATIONHOW MUCHARE YOU WORTH?

INTRODUCTION: DUDE, DON'T
FREAK

I KNOW WHAT
YOU ARE
SAYING…
OH GOD.
ANYTHING
BUT FINANCE.

BUT, SERIOUSLY. DON'T SWEAT IT.
I KNOW WHAT
YOU ARE
SAYING…
OH GOD.
ANYTHING
BUT FINANCE.

I KNOW WHAT
YOU ARE
SAYING…
OH GOD.
ANYTHING
BUT FINANCE.
FINANCE IS ACTUALLY QUITE SIMPLE

I KNOW WHAT
YOU ARE
SAYING…
OH GOD.
ANYTHING
BUT FINANCE.
FINANCE IS ACTUALLY QUITE SIMPLE
WHEN YOU FOCUS ON WHAT MATTERS.

AND YOU CAN'T AVOID IT.
BECAUSE IF YOU LOOK WEAK

IF YOU ACTUALLY LET
EXCEL KNOW YOU'RE
SCARED

IF YOU ACTUALLY LET
EXCEL KNOW YOU'RE
SCARED
THEN YOU'LL BE ON
YOUR ASS

SO LET'S TALK ABOUT VALUATION
SINCEYOUCAN’T
AVOIDIT

SINCEYOUCAN’T
AVOIDIT
SINCE IT'S NOT ACTUALLY
THAT HARD

SINCE IT'S NOT ACTUALLY
THAT HARD
AND SINCE IT IS ONE OF
THOSE TOPICS THAT
ABSATIVELY CANNOT BE
DELEGATED TO FINANCE
SINCEYOUCAN’T
AVOIDIT

VALUATION IS THE
PROCESS OF
DEFINING WHAT
YOUR START-UP
IS WORTH!
DEFINITION

DEFINITION VALUATION IS
THE PROCESS OF
DEFINING WHAT
YOUR START-UP
IS WORTH!
YOU DO THAT IN 3 SIMPLE WAYS

THE PROCESS OF
DEFINING WHAT
YOUR START-UP
IS WORTH!
YOU'RE WORTH WHAT YOU
OWN

THE PROCESS OF
DEFINING WHAT
YOUR START-UP
IS WORTH!
OWN
CAN EARN IN THE FUTURE

THE PROCESS OF
DEFINING WHAT
YOUR START-UP
IS WORTH!
OWN
YOU'RE WORTH WHAT THE
MARKET SAYS YOU'RE
WORTH

LET'S GO THROUGH EACH
OF THOSE…

PART 1
OWN

VALUATION BASED ON ACTUAL
ASSETS IS PROBABLY THE SIMPLEST
AND MOST INTUITIVE

YOU ARE WORTH EXACTLY HOW MUCH
YOU HAVE IN YOUR POCKET!
* (ADVANCED READER: WHAT IS IN YOUR BALANCE SHEET TODAY?)

ACTUALLY, WHAT YOU’RE WORTH
RIGHT NOW CAN BE DIVIDED INTO 2
MAJOR CATEGORIES OF VALUE

TANGIBLE ASSETS INTANGIBLE ASSETS
INVENTORY
CASH OR FINANCIALASSETS
BUILDINGS, LAND, VEHICLES,
EQUIPMENT
COMPUTERS, DESKS,
CHAIRS (ANYTHING YOU
CAN HOCK)
ACCOUNTS RECEIVABLE
(WHAT PEOPLE OWE YOU)
AGREEMENTS THAT
COULD BE NOVATED
(FRANCHIZE OR
DISTRIBUTION
AGREEMENTS)
COPYRIGHTS
PATENTS
TRADEMARKS
TRADE SECRETS
BRAND / REPUTATION
UNIQUE KNOWLEDGE

SO THE FIRST THING YOU NEED TO DO
IS FIGURE OUT HOW MUCH YOU CAN
SELL ALL THE TANGIBLE & INTANGIBLE
ASSETS FOR

YOU’LL PROBABLY ALSO HAVE SOME
LIABILITIES TOO

RENTAL AGREEMENTS
ACCOUNTS PAYABLE
BANK LOANS
UNPAID SALARY
SALARY LIABILITIES (NOTICE PERIODS)
TAX OWED
BONDS
LEASES
PENSION CONTRIBUTION
PRODUCT WARRANTIES
OTHER CONTINGENT LIABILITY

YOU NEED TO SUM UP ALL THESE
LIABILITIES AS WELL

AND WHEN YOU DO THAT, YOU’RE
READY TO VALUE YOUR FIRM:
FIRM VALUE =
(TANGIBLE + INTANGIBLE ASSETS) - LIABILITIES

OF THE 3 METHODS, THIS RESULTS IN
THE LOWEST VALUATION

WHICH IS WHY, IT IS REALLY ONLY USED
DURING LIQUIDATIONS

PART 2

OF COURSE THE ASSETS & LIABILITIES
METHOD DOES NOT WORK WELL WHEN
YOU ARE PITCHING A TRUE START-UP
WHICH HAS NOTHING OTHER THAN A
BIG DREAM

IN THAT CASE, WE NEED TO VALUE THE
BUSINESS BASED UPON WHAT IS
POSSIBLE IN THE FUTURE

BUT WAIT? WHY WOULD ANYONE
PLACE A VALUE ON POSSIBLE
FUTURE MONEY

WELL IT TURNS OUT THAT POSSIBLE
FUTURE MONEY DOES HAVE VALUE

DEPENDING ON HOW POSSIBLE, AND
HOW MUCH FUTURE MONEY WE’RE
TALKING ABOUT

IF YOUR MOTHER TOLD YOU SHE’D GIVE
YOU 20 DOLLARS TOMORROW IF YOU
DID 1 HOUR OF CHORES TODAY, WOULD
YOU DO IT?

YOU TRUST MOM. YOU NEED THE
DOUGH TOMORROW. SO YOU’LL PAY IN
ADVANCE

YOU SEE. PROMISED FUTURE MONEY
DOES HAVE VALUE TODAY

HOW ABOUT IF A BANK TOLD YOU THAT
THEY’D GIVE YOU A GUARANTEED 110
DOLLARS IN A MONTH IF YOU
DEPOSITED 100 DOLLARS TODAY?

THE POINT IS THAT THERE IS DEFINITELY
VALUE TODAY FOR FUTURE MONEY

THE VALUE OF FUTURE MONEY AND
THE VALUE OF MONEY TODAY IS NOT
EQUAL

WOULD YOU PAY ME 100 DOLLARS
TODAY IF I PROMISED THAT I’D RETURN
100 DOLLARS IN 10 YEARS?

COME ON…YOU CAN TRUST ME. I’LL PM
YOU MY BANK DETAILS

FIRST, IF YOU DEPOSITED THE 100
BUCKS IN A BANK, YOU’D GET MORE
THAN 100 BACK IN TEN YEARS BECAUSE
OF INTEREST
(WELL MAYBE NOT MUCH MORE)

IN OTHER WORDS, THE VALUATION OF
FUTURE PROMISED MONEY IS
AFFECTED BY OPPORTUNITY COST

SECOND, WHO’S TO SAY THAT I WON’T
RUN OFF WITH YOUR MONEY, OR GET
HIT BY A BUS

SO NOT ONLY MUST WE CONSIDER
OPPORTUNITY COSTS, WE MUST ALSO
CONSIDER RISKS

IN OTHER WORDS, FUTURE PROMISED
MONEY HAS VALUE TODAY, BUT IT IS
NOT 1 FOR 1 VALUE

FUTURE PROMISED MONEY IS WORTH
LESS THAN THE SAME MONEY RIGHT
NOW.

IN OTHER WORDS, FUTURE MONEY
NEEDS TO BE DISCOUNTED

FORTUNATELY, AN ARMY OF
MATHEMATICIANS WORKED THEIR
MAGIC AND CAME UP WITH A COUPLE
OF NIFTY FORMULAS

INTERNAL RATE OF RETURN (IRR)
AND
NET PRESENT VALUE (NPV)
(ACTUALLY, IT’S REALLY THE SAME FORMULA, JUST SOLVED FORWARDS AND
BACKWARDS)

THESE FORMULAS LOOK AT YOUR
FUTURE PROMISED CASH FLOWS, AND
DISCOUNT THEM FOR TODAY
(SOMETIMES WE CALL THIS DISCOUNTED CASH FLOW)

IT IS NOT ACTUALLY HARD MATH, BUT IT
ISN’T EASY MATH EITHER
(UNLESS YOU ARE FROM ANYWHERE OUTSIDE OF THE US, IN WHICH CASE, IT IS
EASY)

FORTUNATELY, BILL’S BOYS IN THE MS
EXCEL TEAM HAVE TAKEN THAT MATH
AND TRANSFORMED IT INTO A VERY
SIMPLE FORMULA IN EXCEL WHICH 7 OF
9 CHIMPANZEES CAN USE

THE FORMULA IS:
=NPV (DISCOUNT RATE, CASH FLOW1, CASH FLOW 2,…)

SO, IN ORDER TO USE MS EXCEL TO
CALCULATE YOUR START-UP’S VALUE,
YOU NEED TO KNOW:
WHAT IS THE DISCOUNT RATE
WHAT ARE THE FUTURE CASH FLOWS

GETTING FUTURE CASH FLOWS IS
EASY

YOU JUST GRAB THE PROFIT (NOT
REVENUE) LINE FOR YOUR NEXT 5
YEARS
(YOU GET THAT IN YOUR PRO-FORMA
P&L)
(NOTE FOR ADVANCED USERS: I AM NOT A FAN OF TERMINAL VALUE FOR START-
UPS, SO I WON’T COVER IT HERE. I’M ALSO NOT CONSIDERING DEBT SINCE IT IS A
START-UP. CORPORATE TREASURERS NEED TO READ SOMETHING MORE
ADVANCED THAN THIS DECK, AS I’M SURE YOU REALIZED ALREADY)

CHOOSING THE DISCOUNT RATE
HOWEVER, IS SLIGHTLY HARDER
(SOMETIMES PEOPLE REFER TO DISCOUNT RATE AS WEIGHTED AVERAGE COST OF CAPITAL
OR WACC)

THE DISCOUNT RATE IS A NUMBER
FROM 0 TO 1.
THE CLOSER TO 1 YOU GET, THE MORE
YOU DISCOUNT

SO A DISCOUNT RATE OF .2 (20%) IS
NOT VERY RISKY AT ALL, AND A
DISCOUNT RATE OF .8 (80%) IS SUPER
RISKY.

THE DISCOUNT RATE IS ACTUALLY
CALCULATED BASED ON MANY
CRITERIA

FOR EXAMPLE…

RISK
HOW CONFIDENT IS THE INVESTOR
ABOUT THE LIKELIHOOD THE PROFIT
YOU FORECASTED WILL ACTUALLY
MATERIALIZE (REVENUE AND COST
ASSUMPTIONS ACCURATE?)

OPPORTUNITY COSTS
HOW MUCH MONEY WOULD THE
INVESTOR MAKE IF SHE INVESTED THE
MONEY ELSEWHERE – ESPECIALLY IN
RISK-FREE THINGS LIKE T-BILLS…AND
WHAT ABOUT INFLATION…

MARKET NORMS
THE DISCOUNT RATE WILL ALSO VARY
FROM MARKET TO MARKET WHERE THE
WISDOM OF CROWDS HAS GENERATED
RULES OF THUMB OVER THE YEARS
(IE: PHARMA RATES ARE DIFFERENT FROM E-COMMERCE
PORTAL RATES)

HOWEVER, HERE IS MY PERSONAL
INVESTING RULE OF THUMB,
GENERICALLY

PHASE DISCOUNT RATE
Angel Round .8
Series A .6
Series B .4
Mezzanine .2

IN OTHER WORDS, IF YOU ARE USING
A DISCOUNT RATE OF 50% AT THE
IDEA STAGE, I’M JUST NOT GOING TO
BITE

BECAUSE THERE IS JUST SO MUCH
DAMN RISK THAT YOUR FORECASTS
WILL BE WRONG, OR YOU’LL DIE IN
EXECUTION

AS I NEGOTIATE YOUR DISCOUNT
RATE WITH YOU, I’D ALSO BE
CONSIDERING A MOTLEY OF
FACTORS…

HISTORY OF STABLE GROWTH AND PROFITS
PRODUCT CYCLE POINT
SIZE MARKET SHARE
INDUSTRY
CUSTOMER BASE -DIVERSIFICATION
GROWTH POTENTIAL-TOPLINE AND BOTTOM LINE
TRENDS
COMPETITIVE POSITIONING
PRODUCT MIX
UNIQUENESS
THE VALUE OF SIMILAR COMPANIES
STRATEGY FOR CONTINUED GROWTH AND
PROFITABILITY

SO, BY WAY OF EXAMPLE…IMAGINE A
FRESH START-UP THAT EXPECTS TO
HAVE PROFIT OVER THE NEXT 5
YEARS OF -250,000, 0, 250,000,
2,000,000, & 10,000,000

USING EXCEL, TODAY’S
VALUE OF THIS FIRM’S
FUTURE, PROMISED PROFIT
IS $623,719.
THAT MEANS, IF I INVESTED
$150K TODAY, I’D GET ~25%
OF THE FIRM
(WHICH MEANS 2.5M RETURN IN
YEAR 5 IF WE DISTRIBUTE THE
YEAR 5 PROFIT AND I GET MY 25%)

OK, THAT'S NPV
LET ME QUICKLY MENTION IRR AS
WELL SINCE IRR IS QUITE POPULAR
THESE DAYS

AS WE MENTIONED BEFORE,
INTERNAL RATE OF RETURN (IRR) IS
LIKE STANDING THE NPV FORMULA
ON IT'S HEAD AND SHAKING IT UP AND
DOWN

THE IRR IS THE DISCOUNT RATE THAT
WOULD MAKE THE NPV ZERO
OR, IN OTHER WORDS, THE IRR IS THE
RATE OF EXPECTED GROWTH
THE HIGHER THE IRR, THE BETTER
THE INVESTMENT

AGAIN, BILL'S BOYS CAME TO THE
RESCUE
=IRR (INVESTMENT, CASH FLOW 1, CASH FLOW 2…)

IN THIS EXAMPLE, WE ASSUME
THAT WE INVEST 150K IN A START-
UP. THE INVESTMENT LOSES 250K
IN YEAR 1, BREAKS EVEN IN YEAR
2, MAKES 250K IN YEAR 3, 2M IN
YEAR 4 AND EXITS IN YEAR 5 FOR
10M
GIVEN THIS, THE INVESTOR IRR IS
127.5%
IN OTHER WORDS, WE EXPECT THIS
INVESTMENT TO GROW 127.5%.
MUCH BETTER THAN A SAVINGS
ACCOUNT!

SO….UH…WHICH DO YOU USE: IRR OR
NPV?

HONESTLY, IT DEPENDS ON THE
AUDIENCE
USE WHATEVER THE AUDIENCE
PREFERS

THAT SAID, WHILE IRR IS GREAT FOR
GIANT MULTI-NATIONAL FIRMS, I
PERSONALLY DON'T LIKE IT FOR
START-UPS

TO ME, IRR WORKS BEST WHEN
COMPARING PROJECTS OF EQUAL
RISK OR EQUAL COST & INCOME
REALIZATION

IT IS GREAT FOR A BIG FIRM TRYING
TO COMPARE WHETHER TO BUILD A
NEW DATA CENTER OF EXTEND THE
EXISTING ONE

BUT IMHO, IT IS NOT SO USEFUL AT
COMPARING WHETHER TO INVEST IN A
BIO-INFORMATICS START-UP OR A B2B
E-COMMERCE PORTAL, 2 PROJECTS
WITH SIGNIFICANTLY DIFFERENT RISK
& SPEND PROFILES

THERE IS ONE LAST THING I WANT TO
ADD

IN AN ACQUISITION SITUATION,
RATHER THAN AN INVESTOR
SITUATION, HOPEFULLY THERE IS
SYNERGY VALUE BETWEEN BUYER
AND SELLER

WHICH MEANS THAT PART OF THE
VALUE OF THE DEAL IS NOT JUST
YOUR FUTURE REVENUE, BUT ALSO
THE POSITIVE IMPACT ON THE
BUYER’S REVENUE AS A RESULT OF
THE DEAL

WHETHER THIS CAN BE ADDED TO
THE BASE VALUATION IS UP TO YOUR
NEGOTIATION SKILLS, BUT IMHO, IT
SHOULD BE FACTORED IN TO BE FAIR

PART 3
YOU'RE WORTH WHAT THE
MARKET SAYS YOU'RE WORTH

THE FINAL METHOD OF VALUATION
LEVERAGES THE WISDOM OF
CROWDS

SPECIFICALLY, YOUR VALUE SHOULD
BE SIMILAR TO THE VALUE OF
SIMILAR FIRMS, IN SIMILAR
INDUSTRIES, IN SIMILAR LIFE CYCLE
STAGES, AT THIS POINT IN TIME

BASICALLY, YOUR VALUE IS THE
VALUE THAT THE INVISIBLE HAND OF
THE MARKET GIVES YOU

THE MOST COMMON WAY TO
GUESTIMATE MARKET VALUE IS TO
LOOK AT COMPARABLES (SIMILAR-ISH
COMPANIES TO YOURS)

AND SINCE NO COMPANY IS JUST LIKE
YOURS, YOU NEED TO TAKE A BUNCH
OF DATA POINTS TO TRIANGULATE

THIS IS USUALLY DONE WITH P/E
RATIO
ACTUALLY, YOU CAN SOMETIMES ALSO CONSIDER: PRICE TO BOOK RATIO, EQUITY / SALES,
EQUITY / CASH FLOW, EQUITY / PAT, EQUITY / BOOK VALUE OF SHARE. BUT PE IS FAR
MORE COMMON FOR START-UPS

P/E STANDS FOR
PRICE / EARNINGS
(THINK OF PRICE AS SYNONYMOUS WITH VALUATION
FOR THE MOMENT)

SO IF A FIRM’S VALUE IS 8 MILLION
AND THEIR EARNINGS WERE 2
MILLION, THE P/E RATIO WOULD BE 4
SINCE
8 / 2 = 4

WE REFER TO THE VALUE OF 4 AS
“THE MULTIPLE”

TO GET A VALUE FOR YOU, WE NEED
TO USE THE AVERAGE MULTIPLE
ACROSS ALL THE COMPARABLE
FIRMS WHO HAVE BEEN VALUED.
LET’S ASSUME FOR NOW, THAT THE
AVERAGE MULTIPLE TURNED OUT TO
BE 4

WITH THE MULTIPLE AND YOUR
PROFIT THIS YEAR, WE CAN REVERSE
CALCULATE YOUR PRICE (VALUATION)

IF THE MULTIPLE IS 4
AND YOUR PROFIT WAS 500K, THEN
YOUR VALUATION IS 2 MILLION
PRICE / EARNINGS = MULTIPLE
PRICE = MULTIPLE X EARNINGS
2M = 4 X 500K

THIS MAGICAL MULTIPLE IS NOT AN
ABSOLUTE NUMBER OF COURSE

THE P/E RATIO CAN CHANGE
DRAMATICALLY FROM INDUSTRY TO
INDUSTRY AND IT CAN CHANGE IN THE
SAME INDUSTRY OVER TIME

BECAUSE LIKE ANY WISDOM OF
CROWDS, IT IS SENSITIVE TO MARKET
SENTIMENT

AND MARKET SENTIMENT IS FICKLE,
IRRATIONAL, UNINFORMED, AND FULL
OF EMOTIONS
*(HEY CLASSICAL ECONOMICS…YOU CAN KISS MY A

DURING THE DOT.COM BUBBLE, I SAW
TECH VALUATIONS OF 15X IN ASIA.
WHEREAS TODAY, TECH VALUATIONS
ARE CLOSER TO 4X

THE VALUE OF THESE COMPANIES DID
NOT CHANGE

WHAT CHANGED WAS THE HYPE
SURROUNDING THE MARKET

THANKS FOR READING. I TOLD YOU IT
WASN’T ALL THAT HARD

HERE’S WHAT YOU NEED TO
REMEMBER

THERE ARE 3 WAYS TO VALUE YOUR
FIRM:
1. WHAT YOU OWN (USE ASSETS –
LIABILITIES) – USED FOR LIQUIDATION
2. WHAT YOU’LL EARN IN THE FUTURE (USE
NET PRESENT VALUE) – USED FOR
INVESTMENT
3. WHAT THE MARKET SAYS (USE P/E RATIO) –
USED FOR ACQUISITIONS

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CREATIVE COMMONS ATTRIBUTIONS
Dr. Evil: http://www.flickr.com/photos/bpage/
Attribution Slide: http://www.flickr.com/photos/21572939@N03/
Please note that all content & opinions
expressed in this deck are my own and don’t
necessarily represent the position of my
current, or any previous, employers

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