Ilya strebulaev tec-seminar2010


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Ilya Strebulaev,Stanford GSB, presentation at Deep Dive seminar(

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Ilya strebulaev tec-seminar2010

  1. 1. Valuation and Financing for Entrepreneurs: A One-Hour Crash Course Ilya Strebulaev Stanford GSBIt requires a very unusual mind to undertake the analysis of the obvious Alfred North Whitehead
  2. 2. Our Objectives Four questions we will concentrate on:◮ How to come up with an estimate of the value of your project/firm?◮ How to finance your idea to make it into a successful project into a successful company?◮ How to write financial contracts with your money providers?◮ How to optimize your exit strategy?c Ilya Strebulaev Valuation and Financing 2
  3. 3. c Ilya Strebulaev Valuation and Financing 2
  4. 4. Valuation What information do you need◮ Your free cash flows this year and in the future • free: not re-invested in the firm◮ Your discount rate • Reflects riskiness of the project • Reflects general level of interest rates in the economy • Also called: required rate of return; cost of capitalc Ilya Strebulaev Valuation and Financing 3
  5. 5. Valuation example Ilya Inc.◮ The project costs $15,000 now (2005) to invest◮ The project will bring $10,000 each year in 2006, 2007 and 2008◮ The project has the discount rate of 20% 10, 000 10, 000 10, 000 Net Present Value = −$15, 000+ + 2 + 3 ∼ $6, 000 1.2 1.2 1.2◮ What happens if the discount rate is 50%? 10, 000 10, 000 10, 000 Net Present Value = −$15, 000+ + + ∼ −$1, 000 1.5 1.52 1.53c Ilya Strebulaev Valuation and Financing 4
  6. 6. Main valuation rule Invest in projects that have positive NPV◮ How to estimate cash flows and discount rates for your project/firm?◮ General case: much more difficult to estimate at an earlier stage◮ Look at comparables • Projects/firms/divisions of firms in a similar industry • Valuation of recently sold businesses in your industry/region◮ Look at industry practices/venture capitalist required rate of return◮ Look at your competitive advantagec Ilya Strebulaev Valuation and Financing 5
  7. 7. Stages of financing Seed stage investment◮ Idea◮ Business plan (often a confidential piece) • The proposed product • The potential market • The underlying technology • The needed resources (money, human capital, equipment, time) • The resources currently in place◮ What is crucially important at this stage for money providers • Faith in the entrepreneurial team • Faith in the product◮ Who finances at this stage? • Relatives, friends • Venture capitalists (VC)c Ilya Strebulaev Valuation and Financing 6
  8. 8. Seed financing: Cont’d◮ What are standard contracts between VC and the product team? • Equity: VC becomes a partial owner of the company ∗ Often: preferred equity convertible into common stock · Preferred equity has the first-right advantage over common equity ∗ Use it to your advantage, do NOT be afraid of that! • VC gets a place on the board of directors ∗ Monitoring and control function ∗ Use VC’s expertise◮ How to maximize VC’s faith in your project? • Put your money where your mouth is◮ What you need to be aware of that: • Control function of VC • Example: equity dilutionc Ilya Strebulaev Valuation and Financing 7
  9. 9. c Ilya Strebulaev Valuation and Financing 9
  10. 10. Second-stage financing◮ Common purposes: • Pilot production • Test marketing • Further/larger experiments◮ Who finances at this stage? • The original VC [may have the first priority] • Other VCs, wealthy individuals◮ What form does new financing take? • Preferred/common equity • Convertible debtc Ilya Strebulaev Valuation and Financing 10
  11. 11. Deviation Difference between equity and debt◮ Common equity entitles to ownership of business • “Ownership” means ”Residual cash” • Cash is not promised◮ Debt entitles to pre-specified income • Cash is promised • If not paid, the firm defaults and in the hands of creditors◮ Preferred equity and convertible debt are between equity and debt • Convertible debt is debt that can be converted into equity • Preferred equity is equity with promised dividendsc Ilya Strebulaev Valuation and Financing 11
  12. 12. Equity vs Debt Continued◮ Priority in distribution of profit/assets 1. Senior secured debt [bank debt, some VC debt] 2. Other debt 3. Junior [usually convertible] debt 4. Preferred equity 5. Common equity [owners of the firm: the production team]◮ How to compare various financial securities/contracts: • Differences in cash flow risks • Differences in incentives • Differences in controlc Ilya Strebulaev Valuation and Financing 12
  13. 13. Mezzanine stage financing◮ Purposes: • Full-scale production • Serious marketing◮ Mezzanine investors are different from VC • Lower appetite for risk ... • ... but ready to accept lower returns • Stock/Convertible debt/Debtc Ilya Strebulaev Valuation and Financing 13
  14. 14. Exit strategies◮ Don’t count your chicken until they are hatched◮ But ... • A stitch in time saves nine!◮ Plan your exit strategy in advance◮ Possible outcomes • Sale to a private equity firm, loss of ownership • Merger/acquisition/takover within industry • Initial public offerc Ilya Strebulaev Valuation and Financing 14
  15. 15. Initial public offer◮ Many successful start-ups in the US/UK eventually go public • Continental Europe: most companies remain private◮ Primary vs secondary offering: raising new capital vs cashing in◮ Selecting the market◮ Selecting underwriters • Underwriters: legal/procedural/financial advice, buy the issue and resell◮ Important: any IPO will change the distribution of control in the firm • Public markets have different attitude towards risk than VCsc Ilya Strebulaev Valuation and Financing 15
  16. 16. Financing and valuation: Last word There are three sorts of economists.Those who can count and those who can’t. attributed to John Maynard Keynes