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Valuation for Start-ups
The document discusses the complexities of valuing startups, emphasizing that valuation is a systematic process influenced by various factors such as ownership control and equity dilution during fundraising. It details a case study of a startup named Neuronautica, exploring its funding rounds, expected returns, and the challenges faced in valuing its innovative products. Key concepts include the importance of sound business planning, the valuation methods employed, and the questions investors should consider in the valuation process.
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Valuation for Start-ups
- 1. Demystifying Valuation Presentation atForStartups Dr. G. Sabarinathan December 1, 2012
- 2. What is Value? •Some common barbs about “value” – “Value lies in the eye of the beholder.” – “A cynic is someone who knows the price of everything and the value of nothing.” • Valuation is a systematic, disciplined approach, not a science. • Value = Monetary estimate of the benefit from owning an asset or the right to exploit an asset • Useful for • Raising Capital • Selling /buying / merging businesses and companies • Public floatations Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 3. Why Care AboutValuation • Share of Wealth • Control Two possible outcomes Founder Ownership Founder Ownership After Sharing Before Sharing Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 4. What happens whena company issues shares to raise capital? Demystifying Valuation ForStartups- Dr. G. Sabarinathan
- 5. Equity Dilution Illustrated Positionof HiGrow Ltd., prior to raising any external equity No of shares 1,000 Value of Assets 10,000 Value per share 10 Founder's share 100% Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 6. Impact of Dilution •Let us say until the issue of the Pre Diln Post Diln additional 250 shares, all the shares Founder 100% 80% were held by the promoters. Investor 0% 20% • The promoters held 100% of the equity of the company. Total 100% 100% • This represents 100% of the control Founder 1,000 1,000 as well as wealth of the company. Investor 0 250 • After the dilution the promoters Total 1,000 1,250 share 20% of the control as well as the wealth of the firm. Value 10,000 25,000 • Why would the Founder agree to such a deal? Founder Ownership Founder Ownership Demystifying Valuation ForStartups - Dr. G. Sabarinathan Before Sharing After Sharing
- 7. Equity Dilution No of Shares • Value of the equity before funding Pre Fund Post Fund is Rs 10,000 Rs/ lakhs Rs/ lakhs • Funding causes • Drop in founder’s share of wealth Founder 1000 1000 • Increase in value of firm’s equity Investor 0 250 • Increase in founders’ wealth Total 1000 1250 => “Growing pie” paradigm % Equity • Dilution is financially wise for founder Founder 100% 80% • Investor’s view is another story • Deal will happen only if both see Investor 0% 20% financial sense in the deal, though…. Total 100% 100% Value • Post Money Valuation: Value of firm / equity after Rs/ lakhs Rs/ lakhs funding • Pre money Valuation: Value of equity existing at the Founder 10,000 25,000 time of funding Investor 0 5,000 • Cash: Funding Amount Total 10,000 30,000 • POST–MONEY = PRE-MONEY+CASH Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 8. Neuronautica: The imaginary caseof a start-up with high growth potential Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 9. The Story ofNeuronautica • Founded by three neuro-psychiatrists with collective experience of forty years in dealing with children with Selective Learning Disabilities • Series of products lined up around FocuScience TM, the “Science of Focussing”. • Products claimed to bring about slow transformation in the biochemistry of the brain without the help of chemical-based pharmaceutical products. • Collection of exercises, games and devices to help improve retentivity and problem solving capability through improved concentration • Target: Children in the age group of eight to fourteen years • Non-pharma product: Does not require clinical trials or approvals • Sourcing / manufacturing arrangements tied up • Distribution / marketing possibilities under consideration – Own channel of FocuZonesTM – high investment /risk / return/ model – Distribution through toy stores, supermarkets and malls – Moderate investments in advertisements, inventories and marketing collaterals – Institutional marketing through schools – Low investment, low margin, low volume model Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 10. Product Development Market Development Exit for Early Activity Test Marketing Mfg / Sourcing Stabilisation Biz Expansion Investors? Proof of Concept Mkt Development Mkt Development Biz Model Management Management Risks Management Sourcing / Mfg Growth Sales & Distribution Biz Model Competition Economics Sales & Distribution Stage 4 Economics Stage 3 Cash 100 500 2000 18- 36 months Stage 2 Biz Growth Stage I 12-24 months 0-12 months Elapsed Time Neuronautica Development Roadmap and Funding Plan Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 11. Valuation Two sides & of the same coin Return on Investments The centre-piece of our approach to Valuation Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 12. The Way Investor’sMoney Multiplies Investment Multiple Exit Entry Valuation Valuation Grow at expected rate of return Rs 10 crores Rs 80 crores 8 times ~ 50% CAGR Demystifying Valuation ForStartups - Dr. G. Sabarinathan 12
- 13. Financial data fora similar company / transaction in the market Profit / Share = 10 RoI = 10% Price / Share = 100 or Investment Valuation of Target Profit / Share = 10 Price / Share or = 100 Required RoI = 10% Investment in Target Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 14. Financial data fora similar company / transaction in the market Share Value = 1000 Share Value / Re of sales = 2 Sales = 500 Valuation of Target Estimated Share Value = Sales x Share Value / Re of sales = 1500 x 2 = 3000 10% Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 15. Performance – Return– Valuation Nexus • Sales • EBIDTA Financial Return • EBIT Performance Expectation • PAT • Value / Sales Valuation • Value / Profit Multiple • Value / EBIDTA • Value / EBIT Equity Valuation Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 16. Angel Funding forNeuronautica • The Angel’s questions – How much money does NN require? – How will I get my investment back with a rate of return? Liquidity mechanism? – How long will I have to remain invested – What is an appropriate rate of return? How do I find a benchmark for the rate of return in terms of similarity of • Industry • Stage of evolution • Other risks – Liquidity? Capital Market risks The answers to all of these questions impact the valuation process Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 17. Angel Investment inNeuronautica Funds required Rs 100 lakhs Angel’s expected exit 5 years after investment Angel’s expected multiple on investment 8 times Angel’s expected cash realisation on exit Rs 800 lakhs Expected sales at the end of Year 5 Rs 320 lakhs Valuation of NN at exit = Rs 320 lakhs x 10 Rs 3200 lakhs % of exit valuation required = Rs 800 lakhs / Rs 3200 lakhs = 25% To achieve his return objective the angel requires 25% equity for Rs 100 lakhs of cash Valuation implicit in the transaction = Rs 100 lakhs / 25% = Rs 400 lakhs Demystifying Valuation ForStartups - Dr. G. Sabarinathan 17
- 18. Angel Investment inNeuronautica Funds required Rs 100 lakhs Angel’s expected exit 5 years after investment Angel’s expected multiple on investment 8 times ~ 50% RoI Angel’s expected cash realisation on exit Rs 800 lakhs Expected sales at the end of Year 5 Rs 320 lakhs Valuation of NN at exit = Rs 320 lakhs x 10 Rs 3200 lakhs % of exit valuation required = Rs 800 lakhs / Rs 3200 lakhs = 25% To achieve his return objective the angel requires 25% equity for Rs 100 lakhs of cash Valuation implicit in the transaction = Rs 100 lakhs / 25% = Rs 400 lakhs ……..Needless this rests on many critical assumptions Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 19. Steps in Valuation •Develop a sound business plan • Be clear about all the underlying assumptions • Incorporate the direct and indirect impact of the asset on the other parts of the acquiring organisation • Develop a set of forecast financials – P&L, Balance Sheet, Cash Flow Statement • Decide on appropriate method of valuation • Estimate value • Test Valuation under various scenarios • Decide objective behind purchase – passive interest, joint venture, strategic investment, controlling interest, as the case may be • Add premium, if any, for achieving strategic or other objectives, such as “control”. Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 20. Beyond Angel Fundingfor Neuronautica • On similar lines as in the angel round the company expects to raise a Series A and Series B round of funding as indicated below Series A • Amount Rs 5 crores • % equity issued 20% • Valuation Rs 5 crores / 0.20 = Rs 25 crores • Series B • Amount Rs 20 crores • % equity issued 10% • Valuation Rs 20 crores / 0.10 = Rs 200 crores Demystifying Valuation ForStartups - Dr. G. Sabarinathan 20
- 21. Dilution @ Neuronautica Equity-Promoters Idea Firm Promoter Equity Idea RoundMoney Dilution Promoter% Value Wealth • Promoters + 0 0 0 100% ? ? • Investor(s)-1 Cash (for Product Firm Promoter Development) Value Wealth Equity Idea under RoundMoney Dilution Promoter% • Promoters Development 1 100 25% 75% 400 300 • Investor(s)-1 + • Investor(s) - 2 Cash (for completion Firm Promoter + product launch) RoundMoney Dilution Promoter% Value Wealth 1 100 25% 75% 400 300 Equity Business Expansion 2 500 20% 60% 2500 1500 • Promoters + • Investor(s) - 1 Cash • Investor(s) - 2 Firm Promoter RoundMoney Dilution Promoter% Value Wealth 1 100 25% 75% 400 300 2 500 20% 60% 2500 1500 Demystifying Valuation ForStartups - Dr. G. Sabarinathan 3 2000 10% 54% 20000 10800
- 22. Challenges in ValuingNeuronautica • Apart from lab level evidence hardly any information on • The effectiveness of the product in the field • Acceptance of the product • Challenges in sales and distribution • Untried management team • How far can they take this business? • Can you find people beyond the founders’ ability? • Will the founders agree to step aside if found necessary? • The economics of the business under different business / operating models • How will the investor realise his returns? • The virtues of staged financing • For the entrepreneur: Helps demonstrate value • For the investor: Helps discover value / uncover risks • The trouble with staged financing: How will the market respond when the company needs to raise money as planned? Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 23. Final Questions andThoughts 1. What drives Valuation 2. How is the divergence in the outlook valuation addressed? 3. Does Valuation depend on other terms of a deal? 4. Does Valuation have to be frozen at the time of raising a round of funding? 5. Do deals fall through on Valuation? 6. Does modelling help improve Valuation? 7. How much effort / time does one spend modelling valuation? 8. Where does one find the information required for Valuation? 9. How reliable are published information on Valuation? 10. Is it worth turning to a professional for Valuation? Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 24. Drivers of Valuation •Environment Related – Macro-economic outlook – Industry Outlook – Liquidity Overhang • Firm Related – Fundamentals of the firm, esp. strategic aspects. • Deal Related – Stage of investment and expected investment horizon – Relative size of exposure in relation to the size of the deal. – Previous round investors’ expectations – Exit prospects and path • Valuation Trends – Comparable deals. Caution : Compare likes. – Public market valuations and liquidity Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 25. Rejection rate, importanceand reasons by stage *Effort measured as dollar value, as perceived by the respondents **Rejection rate – of a total of 100 approaching the VC, the number rejected at this stage Investment Initial interaction & ‘Research’ and Short- Business plan Due diligence and sharing the business Listing presentation Negotiations idea Effort* 23% 52% 29% 38% 10% Rejection Rate** 59% 76% 17% 14% 5% 5% • Interest mismatch - • Too small market size or • Poor planning – unrealistic • Unrealistic valuation projections entrepreneur is pre-qualified and coached inappropriate vertical or potential • Too high expectations from geography • Easily replicable plan • Entrepreneur’s rigidness the management • Financial, marketing or to modify plans as Key Reasons for rejection • Closer look contrary to Most reasons can be avoided if • Lack of consensus on sustainability related initial perceptions proposed by the investor • Communication issues governance, valuation etc • Lack of confidence in • Unable to convince about • Lack of track record of the • Legal issues management as opportunity feasibility/ execution/ entrepreneur bigger than what was expansion/ sustainability • Adverse report on • Vague or unstable plan management/ business • Bad timing – too early or proposed initially • Unrealistic demands from • Lack of expectation entrepreneur • Management’s rigidness to ‘me-too’ offering • Not addressing a need/ non- alignment • Lack of confidence due to accept investor’s terms viable, too opportunistic, • Competitive aspects inability to sustain cross- too small a market potential • Unfavourable feedback on questioning • Execution doubts management/ market • Legal issues & other • Non serious entrepreneurs • ‘Wildcard’ deal spoilers ‘wildcard events’ walking in just to validate the idea Initial stages consume over half the effort and filter-out just 76% of the deals, suggesting that there is an opportunity to improve the efficiency of entrepreneur-investor interaction. Demystifying Valuation ForStartups - Dr. G. Sabarinathan 25 Source: Stern Fisher-IVCA Presentation
- 26. Observations on Fundingand Valuation • Multiple rounds are not just important but inevitable for early stage, high growth businesses Control vs Wealth Trade-off • Multiple stages mean progressive dilution • Successful development of investee means wealth of founders’ as well as early round investors grows in spite of decline – Equally, unsuccessful development could mean “washing out” of incumbents’ wealth • Challenges – Anticipating requirement of funds: Too much vs Too little – Firming up key strategic choices – Calling capital market conditions – Bases of Valuation – Forecasting performance and “Incentives” Demystifying Valuation ForStartups - Dr. G. Sabarinathan
- 27. Information on Valuation •Public Information easily available now – Websites of ET, Moneycontrol… – Commercial databases: Prowess, Capitaline, Bloomberg • Private Information hard to come by • Newspaper reports • Databases like Venture Intelligence,VC Circle • Specialised Intermediaries – Caveat: Be careful about special terms
- 28. THANK YOU Demystifying ValuationForStartups - Dr. G. Sabarinathan
- 29. Agenda • What arewe valuing? • What happens when a company issues new shares to raise new funds? • Financing a high growth growing start-up: A flight of imagination • Valuation Challenges • How do VCs and angels carry out valuation • Steps to Valuation • Factors Influencing Valuation • Closing Thoughts Demystifying Valuation 29