Valuations w/ Jeff Faust

Start-Up Valuations
By Jeff Faust, CVA
Director of Valuation Services
October 27
2015

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.
2
 Jeff Faust qualifications
 FMV vs Investment Value
 409A Overview
 Overview of Valuation Methods
 Sample valuation methods
 Pre-revenue, pre-funding (FMV)
 Pre-revenue, pre-funding (Investment Value)
 Post-funding (FMV)
 Profitable (FMV)
Objective of Presentation

3
 ASL Director of Valuation Services
 25 years in finance, serial entrepreneur.
 20 years in Business Valuations.
 Over 65 different industries.
 All sizes and stages of development.
 Employee Stock Ownership Plans (ESOPs), Stock Options (409A), Family Limited
Partnerships (FLPs), Buy-Sell Agreements, Estate/Gift Taxes, Mergers/Acquisitions
and Transactions, Litigation Support.
 Testified in front of the Department of Labor and in several Superior Courts in the Bay
Area.
 Certified Valuation Analyst (CVA) with the National Association of Certified Valuators
and Analysts (NACVA).
 Instructor for the Venture Capital Academy (VCA).
 Co-Founder of SaaS Company (Equity Management Software)
Jeff Faust Background

4
Valuation Workshop
 FMV vs Investment Value

5
Valuation Workshop
 Overview of 409A
 Deferred comp IRC Section
 No discounted options (ISO’s and NQSO’s must be granted at FMV)
 Options granted must follow 1 of 3 valuation methods

6
Valuation Methods
 Is there one formula for valuation?
Income *
---------- = Value
Risk
* Could be historical or projected but in all cases it is “normalized”

7
Valuation Methods
Most common
 Income Approaches (DCF, DFE, Capitalized Earnings)
 Market Approaches (Guideline, M&A and Comparable Transaction)
 Asset Approaches (Book Value, Restated Net Worth)
Others used
 Cost (Replacement)
 Asset and Income Approaches (Excess Earnings)
 Other / Start-Up Approaches (VC Method, Exit Multiples, Preferred
Rounds, Berkus Method, Scorecard Method, Cayenne Calculator,
People & Patents, Risk Factor Summation)

8
Valuation Preparation (Know what Stage you are in!)
 Stage of Development
Stage
Abbreviated
Description Description
1 Start-up Enterprise has no product revenue and limited expense
history. Typically an incomplete management team has an
idea, plan, and possibly some initial product development.
Seed capital or first-round financing is usually provided by
friends and family, angels, or venture capital firms focusing on
early-stage enterprises. The securities issued to those
investors are occasionally in the form of common stock but are
more commonly in the form of preferred stock.
2 Development Enterprise has no product revenue but substantive expense
history. Product development is underway and business
challenges are thought to be understood. Typically, a second
or third round of financing occurs during this stage. Investors
are usually venture capital firms which may provide additional
management or board of directors’ expertise. Securities
issued are typically in the form of preferred stock.
3 Alpha/Beta Enterprise has made significant progress in product
development; key development milestones have been met
(e.g. hiring of the core management team); and product
development is near completion (e.g. alpha and beta testing
of the product, service, web site). Third party revenue is
beginning, although there may have been progress/milestone
payments from strategic business partners. Later rounds of
financing occur during this stage. Typical investors are venture
capital firms and strategic business partners. The typical
securities issued to those investors are in the form of
preferred stock.
4 Early Revenue Enterprise has met additional key development milestones
(e.g. growing customer orders and revenue shipments). It
has a sufficient customer base to support ongoing operations,
but is still operating at a loss. A manufacturing and
distribution plan is being implemented Typically, mezzanine
rounds of financing occur during this stage. Discussions
frequently start with potential acquirers or investment banks
for an initial public offering (IPO).
2 Development Enterprise has no product revenue but substantive expense
history. Product development is underway and business
challenges are thought to be understood. Typically, a second
or third round of financing occurs during this stage. Investors
are usually venture capital firms which may provide additional
management or board of directors’ expertise. Securities
issued are typically in the form of preferred stock.
3 Alpha/Beta Enterprise has made significant progress in product
development; key development milestones have been met
(e.g. hiring of the core management team); and product
development is near completion (e.g. alpha and beta testing
of the product, service, web site). Third party revenue is
beginning, although there may have been progress/milestone
payments from strategic business partners. Later rounds of
financing occur during this stage. Typical investors are venture
capital firms and strategic business partners. The typical
securities issued to those investors are in the form of
preferred stock.
4 Early Revenue Enterprise has met additional key development milestones
(e.g. growing customer orders and revenue shipments). It
has a sufficient customer base to support ongoing operations,
but is still operating at a loss. A manufacturing and
distribution plan is being implemented Typically, mezzanine
rounds of financing occur during this stage. Discussions
frequently start with potential acquirers or investment banks
for an initial public offering (IPO).
5 Positive Cash
Flow
Enterprise has a history of product revenues, and has recently
achieved breakthrough measures of financial success, such as
operating profitability or positive cash flows. Regulatory
approvals (e.g. Food and Drug Administration) have been
obtained. A liquidity event, such as an IPO or a sale of the
enterprise, could occur late this stage.
6 IPO Enterprise has an established financial history of profitable
operations and generation of positive cash flows. It is a
mature candidate for acquisition or an IPO. The form of
securities issued is typically all common stock, with any
outstanding preferred converting to common upon an IPO
(and perhaps also upon other liquidity events).

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 Risk Discounts – Ranges for Start-Ups
Stage of
Development Characteristics
Frei & Leleux
Life Sciences
Study (1)
Seiffer
Software
Study (2)
Plummer
Study (3)
Scherlis and
Sahlman
Study (4)
Sahlman,
Stevenson
and Bhide
Study(5)
Start-up Pre-prototype 70% - 100% 60% - 80% 50% - 70% 50% - 70% 50% - 100%
Early development Pre-commercialization 50% - 70% 50% - 60% 40% - 60% 40% - 60% 40%-60%
First Stage Commercialization 40% - 60% 40% - 50% NA NA NA
Expansion Shipping Product 35% - 50% 30% - 40% 35% - 50% 30% - 50% 30%-40%
Mezzanine/ IPO Profitable 25% - 40% 25% - 30% 25% - 35% 20% - 35% 20%-30%
(1) Frei, P. & Leleux, B. Valuating the Company. Starting a Business in the Life Sciences- from Idea to Market. (Luessen, H. (ed.).) 42-55 (Edition Cantor Verlag,
Aulendorf, Germany, 2003).
(2) John Seiffer, "The Business of Software: The Venture Capital Rate of Return". < http://discuss.joelonsoftware.com/default.asp?biz.5.254929.9> (21 November
2005)
(3) Plummer, James L., QED Report on Venture Capital Financial Analysis, Palo Alto: QED Research, Inc., 1987
(4) Scherlis, Daniel R. and Sahlman, William A., "A Method for Valuing High-Risk, Long Term, Investments: The Venture Capital Method," Harvard Business School
Teaching Note 9-288-006, Boston: Harvard Business School Publishing, 1989
(5) Sahlman, William A. and Howard H. Stevenson, Amar V. Bhide, “Financing Entrepreneurial Ventures”, Business Fundamental Series, Boston: Harvard Business
School publishing, 1998.
Valuation Preparation
(What discount range is appropriate)

10
Sample Valuation Methods
 Cost Approach
Est Repl Cost (low) Est Repl Cost (high)
Current Expenses $400,000 $400,000
Services In Lieu $200,000 $400,000
Estimated Replacement Cost $600,000 $800,000
Equity Value $600,000 $800,000
Shares Issued 12,000,000 12,000,000
Stock Option Pool 3,000,000 3,000,000
Fully Diluted Shares 15,000,000 15,000,000
Price / Share $0.040 $0.053
$0.05
Pre-Revenue, Pre-Funding (FMV)

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 Funding
Pre-Revenue, Pre-Funding (Investment Value)
Pre and Post Money Illustrations (value continuation)
A Round B Round
Pre Money Valuation 4,000,000$ Pre Money Valuation 5,000,000$
Pre A Shares 15,000,000 Pre B Shares 18,750,000
Px/Share of Preferred A 0.27$ Px/Share of Preferred B ** 0.27$
Money Raised 1,000,000$ Money Raised 1,250,000$
Share Issued for A 3,750,000 20% Share Issued for B 4,687,500 20%
Post A Shares 18,750,000 Post B Shares 23,437,500
Post Money Valuation 5,000,000$ Post Money Valuation 6,250,000$
** Although the price per share is the same, the Post Money Valuation is clearly higher after the B Round

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 Funding
Pre-Revenue, Pre-Funding (Investment Value)
Pre and Post Money Illustrations (value increase)
A Round B Round
Pre Money Valuation 4,000,000$ Pre Money Valuation 10,000,000$
Pre A Shares 15,000,000 Pre B Shares 18,750,000
Px/Share of Preferred A 0.27$ Px/Share of Preferred B 0.53$
Money Raised 1,000,000$ Money Raised 2,500,000$
Share Issued for A 3,750,000 20% Share Issued for B 4,687,500 20%
Post A Shares 18,750,000 Post B Shares 23,437,500
Post Money Valuation 5,000,000$ Post Money Valuation 12,500,000$

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How do preferred terms impact value?
 CVM – The Effect of Different Capital Structures
Company 1 Company 2 Company 3
(No Preferred) (Non-Participating) (Full Participation)
Assumptions
Value $12,000,000 $12,000,000 $12,000,000
Common Shares Outstanding 12,000,000 12,000,000 12,000,000
Preferred Shares Outstanding 4,000,000 4,000,000
(Assume Liquidation Preference is $1/share)
Share Calculation
Value $12,000,000 $12,000,000 $12,000,000
Less: Liquidation Preference $0 $4,000,000 $4,000,000
Equals: Remaining Amount $12,000,000 $8,000,000 $8,000,000
Divided by: Shares 12,000,000 12,000,000 16,000,000
Equals: Price Per Share $1.00 $0.67 $0.50

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 VC Method
(Pre-)Revenue, (Pre-)Funding (Investment Value)
Year 1 Year 2 Year 3 Year 4 Year 5
Revenue Projections 1,000,000 5,000,000 20,000,000 50,000,000
Which year will you be profitable? 4
What is your Peer Group Multiple? 3 (Software = 2-3, SaaS = 4-6, Cloud = 5-8, Data = 8-12, Social = 10+)
Percent of Projections 50%
Implied Future Valuation 30,000,000
Enter discount rate (stage chart) 90%
Estimated Funding Valuation 2,300,000

15
 VC Method – Multiples (Peer Group) ($US in millions)
Market Value of Invested Capital (MVIC) as a Multiple of:
TTM TTM TTM NFY
Revenue EBITDA EBIT Revenue
2.7 x 9.2 x 12.7 x 2.5 x
2.4 x 8.6 x 10.4 x 2.3 x
4.2 x 16.5 x 17.9 x 3.8 x
5.6 x NM NM 3.0 x
16.9 x NM NM 10.6 x
3.6 x 16.1 x 19.7 x 3.3 x
Maximum 16.9 x 16.5 x 19.7 x 10.6 x
Third Quartile 5.3 x 16.2 x 18.3 x 3.7 x
Average 5.9 x 12.6 x 15.2 x 4.3 x
Median 3.9 x 12.7 x 15.3 x 3.2 x
First Quartile 2.9 x 9.1 x 12.1 x 2.7 x
Minimum 2.4 x 8.6 x 10.4 x 2.3 x
Harmonic Mean 3.9 x 11.5 x 14.2 x 3.3 x
Coefficient of Variance 94% 34% 29% 74%
Selected Multiples 2.9 x 9.1 x 12.1 x 2.7 x
Sample Company's Financials 5.200$ (9.562)$ (10.562)$ 15.265$
Indicated MVIC Value Range 15.080 (87.014) (127.800) 41.216
Weighting 0% 0% 0% 100%
Implied Market Value of Invested Capital 41.200$
Less: Debt 10.500
Total Equity Value (Non-controlling, Marketable) 30.700$
Less: Discount for Lack of Marketability 35.0% 10.745
Total Equity Value (Non-controlling, Non-marketable) 19.955$
Perrigo Co.
Zalicus Inc.
Company Name
Abbott Laboratories
Baxter International Inc.
Mead Johnson Nutrition Company
Amicus Therapeutics, Inc.
(Pre-)Revenue, (Pre-)Funding (Investment Value)

16
Scorecard Method
 Two-Step
 (1) determine average pre-money of companies like yours
 (2) compare target to perception of similar deals
 Strength of Management Team 0-30%
 Size of the Opportunity 0-25%
 Product/Technology 0-15%
 Competitive Environment 0-10%
 Marketing/Sales Channels/Partnerships 0-10%
 Need for Additional Investment 0-5%
 Other 0-5%
--------
100%
Early Stage (Investment Value)

17
Scorecard Method
Software Company
A company has an above average product and technology (125% of
norm), an average management team (100% of norm) and a large
market opportunity (150% of norm). The company can get to
positive cash flow with two rounds of angel investment (80% of
norm). Looking at the strength of competition in the market, the
target is average (100%) but early customer feedback on the product
is excellent (Other = 100%). The company needs some additional
work on building sales channels and partnerships (75%).

18
Scorecard Method
COMPARISON
FACTOR
RANGE
TARGET
COMPANY
FACTOR
Strength of
Management Team
30% 100% 0.3000
Size of Opportunity 25% 150% 0.3750
Product/Technology 15% 125% 0.1875
Competitive
Environment
10% 100% 0.1000
Marketing/Sales/
Partnerships
10% 75% 0.0750
Need for Additional
Investment
5% 80% 0.0400
Other factors 5% 100% 0.0500
Sum: 1.1275
Assuming the average pre-money valuation is $2.7
million, we multiply that figure with the Sum of
Factors (1.1275 x $2.7 million). Therefore, we arrive
at a pre-money valuation of $3.04 million.

19
Berkus Method
 Developed by Dave Berkus of Tech Coast Angels
Characteristic Add to Pre-money Valuation
Quality Management Team 0 - $500,000
Sound Idea 0 - $500,000
Working Prototype 0 - $500,000
Quality Board of Directors 0 - $500,000
Product Rollout or Sales 0 - $500,000

20
Berkus Method
Characteristic
Add to Pre-money
Valuation
Target Company
Quality Management
Team
0 - $500,000 $375,000
Sound Idea 0 - $500,000 $425,000
Working Prototype 0 - $500,000 $500,000
Quality Board of
Directors
0 - $500,000 $375,000
Product Rollout or
Sales
0 - $500,000 $375,000
TOTAL 0 - $2,500,000 $2,050,000

21
People and Patents
 Each patent and engineers is ~$1M

22
Risk Factor Summation
 Series of Questions
 Management, State of the business, Legislation/Political risk, Manufacturing risk,
Sales and marketing risk, Funding/capital risk, Competition risk, Technology risk,
Litigation risk, International risk, Reputation risk, Potential lucrative exit
 +2 for very positive, +1 positive, 0 neutral, -1 negative, -2
very negative
 For every +1 you add $250,000 (+$500k for +2) and subtract
$250,000 for every -1 (-$500k for a -2)

23
Risk Factor Summation
Assume the average pre-
money valuation is $2.3 million,
and after tallying the points, the
sum is +1.
Therefore, you would add
$250,000 to the $2.3MM
average, bringing the
company’s pre-money value to
$2.55 million.
Risk Factors Risk Rating
Management 0
State of the Business +1
Legislation/Political Risk 0
Manufacturing Risk 0
Sales and Marketing Risk -1
Funding/Capital Risk -1
Competition Risk 0
Technology Risk +1
Litigation Risk 0
International Risk 0
Reputation Risk 0
Potential Lucrative Exit +1
TOTAL =+1

24
Cayenne Calculator
 www.caycon.com/valuation.php
 Series of questions
Any Stage (Investment Value)

25
Summary of Values
Method Software
VC Method $2.30 Million
Scorecard $2.59 Million
Berkus $2.05 Million
Cayenne $1.84 – $2.25 Million
Risk Factor $2.55 Million

26
 Discounted Cash Flow (DCF) – [exit multiples]
Projected Financials
FYE FYE FYE FYE FYE
12/31/12 12/31/13 12/31/14 12/31/15 12/31/16
Projected Earnings (9.238)$ (5.235)$ 1.528$ 6.859$ 10.537$
Terminal Value Calculation
Revenue Multiple 12/31/16 165.526$ 2.7
Terminal Value 430.37$
Present Value Period 1.00 2.00 3.00 4.00 5.00 5.50
Present Value Factor (3)
60.0% Discount Rate 0.624 0.390 0.244 0.152 0.095 0.075
Present Value of Debt-free Cash Flow (5.782)$ (2.042)$ 0.373$ 1.045$ 1.004$ 32.406$
Sum of Present Value of Debt-free Cash Flow in Projection Period (5.403)$
Plus: Present Value of Terminal Value 32.406
Total Equity Value (Controlling, Marketable) 27.003$
Less: Discount for Lack of Control 0.0% -
Total Equity Value (Non-controlling, Marketable) 27.003$
Less: Discount for Lack of Marketability 35.0% 9.451
Total Equity Value (Non-controlling, Non-marketable) 17.552$
Terminal
Year
Post-Funding (FMV)

27
 Discounted Future Earnings (DFE)
Profitable (FMV and Investment Value)
Projected Financials
FYE FYE FYE FYE FYE
12/31/12 12/31/13 12/31/14 12/31/15 12/31/16
Projected Earnings 1,454,100$ 1,537,125$ 1,703,328$ 1,885,410$ 2,181,030$
Terminal Value Calculation
Gordon Growth Method 23.0% risk rate, 3.0% growth rate
Terminal Value 11,232,307$
Present Value Period 1.00 2.00 3.00 4.00 5.00 5.00
Present Value Factor 23.0% Discount Rate 0.813 0.661 0.537 0.437 0.355 0.355
Present Value of Net Income 1,181,525$ 1,015,436$ 914,822$ 823,264$ 774,265$ 3,987,467$
Sum of Present Value of Net Income in Projection Period 4,709,312$
Plus: Present Value of Terminal Value 3,987,467
Indicated Equity Value 8,696,779$
Less: Discount for Lack of Control 0.0% -
Total Equity Value (Non-Controlling, Marketable) 8,696,779$
Less: Discount for Lack of Marketability 35.0% 3,043,872
Total Equity Value (Non-Controlling, Non-marketable) 5,652,906$
Terminal
Year

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Great Website Resources
 https://angel.co/
 http://visual.ly/vizbox/startup-universe/
(search for “Startup Universe”)

29
Q & A
 Any questions?

30
Jeff Faust, CVA
jfaust@aslcpa.com
(408) 377-8700 x232
Contact Information
Abbott Stringham & Lynch
1550 Leigh Avenue
San Jose, CA 95125
(408) 377-8700

Valuations w/ Jeff Faust

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