The document provides a comprehensive overview of valuation methods for both mature companies and startups, detailing various approaches such as asset-based methods, relative valuation, and absolute valuation. It discusses key concepts like risk versus reward, market traction, and criteria for assessing pre-revenue and post-revenue valuations. Additionally, it includes specific models and methodologies such as the Berkus method and venture capital method, emphasizing the importance of market factors and team strength in startup valuations.

1. Valuation
A BRIEF REVIEW BY MOHAMMAD AHMADI
SMARTUP.IR
@AHMADINVEST
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2. Scope
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Now this is not the end.
It is not even the beginning of the end.
But it is, perhaps, the end of the beginning.
Winston Churchill

3. Contents
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Introduction
Valuation of Mature Companies
Valuation of Start ups
Pre-Revenue Valuation
Post-Revenue Valuation
Rules to Remember

4. Introduction
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5. What is finance
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Finance describes the management, creation and study of money, banking,
credit, investments, assets and liabilities that make up financial systems, as well
as the study of those financial instruments.
To put it in a nutshell, Finance is the Study of Value.

6. What is Value
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 The monetary, material or assessed worth of an asset, good or service.
 Value is used to quantify the worth of something, and different types of value
can be applied to explain various situations
 Value can be perceived, as in the way consumers perceive the ability of a good
or service to meet their needs and their willingness to pay for the good or
service.

7. Types of Value
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 Market Value
 Liquidation value
 Book Value
 Replacement Value
 Historical Value
 Intrinsic value

8. Sources of Value
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 Time
 Uncertainty

9. Required Information
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 Cash Flow Stream
Discount Rate

10. Life Cycle of a Start-up
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11. Valuation of Mature Companies
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12. Approaches to Valuation
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 Asset-Based Methods
 Liquidation Value Method
 Relative Valuation
 Price Multiples
 Absolute Valuation
 Free Cash Flow
 Dividends
 Option-Based Valuation

13. Liquidation Value Method
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 This may not be a very wise tool to measure a profitable company as it ignores
the future growth potential.
This method can be considered to evaluate a dying company as a potential
takeover and sell down for profit making.

14. Relative Valuation
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Compares a firm's value to that of its competitors to determine the firm's
financial worth.

15. Price-to-Earnings (P/E)
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Pros
Easy to use
 Most commonly used measure of valuation
 Studies have indicated a strong correlation to long-term returns.
Cons
 Cannot be used for firms when they report a loss in earnings.
 Earnings can be volatile given various inputs.
Earnings are more easily manipulated by managements.

16. Price-to-Book Value (P/BV)
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Pros
 Tends to be a stable valuations metric because balance sheets do not fluctuate much
quarter-to-quarter.
 Can be used as a valuation metric even when firms report an EPS loss.
 Good metric to value firms in distress
Cons
 Does not take into account the relative asset size when comparing firms.
 Accounting metrics can skew the results.
 Book value is not an accurate measure of actual market value.

17. Price-to-Sales (P/S)
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Pros
Sales tend to be a realistic number and are not influenced as heavily by accounting
issues.
 Good metric to value firms in distress.
 Can be used as a valuation metric when firms report a loss.
Cons
 Sales do not always translate to profits which can leave out the cost component.
 Difficult to value companies with different cost structures.
 Accounting issues related to revenue recognition can still alter sales.

18. Price-to- Cash Flow (P/CF)
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Pros
 Cash flow is a truer metric of a company's results in comparison to earnings.
 It is more difficult for managements to manipulate cash flow
 Tends to be less volatile than earnings.
 Studies have indicated that it is a reliable metric over the longer-term.
Cons
 Some items are not included, such as non-cash revenue.

19. EV / EBITDA
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Pros
 This ratio is often preferred to other return metrics because it evens out
differences in taxation, capital structure and asset
Cons
 The EV/EBITDA ratio is less widely published than the P/E ratio, making
comparisons difficult.

20. Absolute Valuation
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 Absolute Valuation Models try to determine a company's intrinsic worth based
on its estimated future cash flows discounted to their present value.

21. Absolute Valuation
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Pros
The intrinsic value of an equity can be justified.
 Relies on free cash flows rather than accounting figures.
 Different variations of the model account for different growth rates (e.g.
multistage models).
Cons
 Based on assumptions on inputs (growth rate, required return on equity, and
future cash flows).
 Difficult to forecast cash flows in cyclical businesses.

22. Option Based Valuation (Real Options Analysis)
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 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.
 First, you must figure out the full range of possible values for the underlying
asset.... This involves estimating what the asset's value would be if it existed
today and forecasting to see the full set of possible future values... [These]
calculations provide you with numbers for all the possible future values of the
option at the various points where a decision is needed on whether to continue
with the project

23. Valuation of Startup Companies
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24. What is it About
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Basic finance: ‘risk versus reward’
In startup terminology, it’s: ‘traction versus market size’.
Market traction = market adoption
Traction is evidence that your product or service has started that “hockey-
stick” adoption rate which implies a large market, a valid business model and
sustainable growth.

25. What do you have?
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Assets:
Applications, Product, Cash Flow, Patents, Customers/Users, Partnerships
KPI’s
user growth rate (monthly or weekly), customer success rate, referral rate, daily usage
statistics
Team
Having solid talent in place is something that investors value highly.
What have you built together in the past? Have you ever launched or ran a startup company
in the past? Do you have domain expertise? Have you had a successful exit? Did you work for
a prestigious company or go to an elite school?
If you have none of the above, you haven’t launched anything yet!

26. Pre-Revenue Models
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27. Berkus Method
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Dave Berkus is an active angel investor and lifelong entrepreneur. He came up
with the following early-stage valuation model for startups:

28. Risk Factor Summation Method
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This model takes a broader approach to valuing your company by breaking the
risk down into 12 sub-categories. They are as follows:
1. management 5. sales and marketing risk 9. litigation risk
2. stage of the business 6. funding/capital raising risk 10. international risk
3. legislation/political risk 7. competition risk 11. reputation risk
4. manufacturing risk 8. technology risk
12. potential lucrative
exit

29. Risk Factor Summation Method - Continued
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Each sub-category of risk is assigned a grade of ++, +, 0 (neutral), -, or --. The
scale for scoring each element is:
◦ ++ = add $500 thousand
◦ + = add $250 thousand
◦ 0 = do nothing
◦ - = subtract $250 thousand
◦ -- = subtract $500 thousand

30. Cayanne Consulting Calculator
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Link:
https://www.caycon.com/valuation.php

31. Score Card Valuation Methodology
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 For pre-revenue startup ventures:
First, use the average valuation of recently funded companies in the region to establish a pre-
money valuation of the target.
 Then Adjust the average based on some factors:
 strength of the management team 0-30%
 Size of the opportunity 0-25%
 Product/Technology 0-15%
 Competitive Environment 0-10%
 Marketing/Sales Channels/Partnerships 0-5%
 Need for additional investments 0-5%
 Others 0-5%
Then compare the target company with the norm in each category.

32. Score Card Valuation Methodology – An Example
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 Average pre-money valuation for the pre-revenue firms in the region is $1.5
million.
Consider the following factors:

33. Score Card Valuation Methodology – An Example
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 Comparing the target company with the norm:
1.0750 * 1.5 = 1.61

34. Venture Capital Method
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Return on Investment (ROI) = Terminal (or Harvest) Value ÷ Post-money Valuation
Post-money Valuation = Terminal Value ÷ Anticipated ROI
The selling price can be estimated based on the revenues and estimated earnings in
the year of the sale from industry-specific statistics.
Anticipated ROI: Angel investing is risky business. Based on the Wiltbank Study,
investors should expect a 27% IRR in six years. Most angels understand that half of new
ventures fail and the best an investor can expect from nine of ten investments is return
of capital for a portfolio of ten. Consequently, the tenth investment must be a home run
of 20X or more. Since investors do not know which of the ten will be the homerun, all
investments must demonstrate the possibility of a 10X-30X return.

35. Venture Capital Method – An Example
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A period of 5-8 years after investment, let’s assume 6 years.
Anticipated revenues of $20 million in the harvest year and after-tax earnings
of 15%, or $3 million.
A 15X P/E ratio leads to a Terminal Value of $45 million. A 2X P/S ratio leads to a
Terminal Value of $40 million. Let’s split the difference. In this example, our
Terminal Value is $42.5 million.
A Capital need of $500,000.

36. Venture Capital Method – An Example
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Post-money Valuation = Terminal Value ÷ Anticipated ROI = $42.5 million ÷ 20X
Post-money Valuation = $ 2.125 million.
Pre-money Valuation = Post-money Valuation – Investment = $2.125 – $0.5
million.
Pre-money Valuation = $1.625 million

37. Post-Revenue Models
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38. Baseline valuation figure
Follow these steps to calculate a baseline valuation figure:
Calculate your revenue run rate (RRR), which is the most recent month’s sales
times 12.
Look at your historical growth curve to calculate monthly, or better yet, your
weekly revenue growth rate.
Calculate an adjusted RRR based on your growth rate by applying the growth
rate to the most recent month’s sales and extrapolating out over the course of a
year.
Multiply your adjusted RRR by a factor of ten to put yourself ‘in the ballpark’ of a
rational valuation figure.
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