Company Valuation and Metrics – top down or bottom up?
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Company Valuation and Metrics – top down or bottom up?
- 1. Jeremy Halpern @startupboston Partner, Nutter McClennen & Fish Paulina Hill @paulinahill Polaris Partners Christopher Mirabile @cmirabile Launchpad Venture Group TCN FastTrack – May 2014 Valuing an Early Stage Company #TCNLive
- 2. Sources of early-‐stage capital • Bootstrapping – Founder’s capital and credit cards, bank lines of credit, loans (SBA) • Equity Financing (Early) – Friends and family, crowdfunding, individual angels, organized angel groups, early stage venture capitalists • Equity Financing (Early to Later) – Venture capitalists, corporate venture funds, private equity firms, hedge funds, and ultimately the public markets 2 #TCNlive
- 3. Investment Size Investment “Cost” Traditional VC Micro VC Equipment Financing Angel Groups Angels AngelList Corporate / Strategic Venture Customers Portal Funding Vendors Founder Friends & Family Crowdfunding Grants Venture Debt Bank Loans Personal Loans Private Equity Sources of early-‐stage capital – Cost:Size #TCNlive
- 4. Avoid the “Capital Gap” Stage Pre-‐ Seed Seed Start-‐Up $500,000 to $2,500,000 Early Later Source Founders, Friends and Family Individual Angels, MicroCaps Accelerators Venture Funds Investment $25,000 to $100,000 $100,000 to $500,000 $5,000,000 and up (initial capital may be smaller, but exit targets higher) Market Entry Micro Cap VCs, Angel Groups and Angel Group Syndication 4 Mind the Gap ! #TCNlive
- 5. • Common Equity – Typical for Founders – Not typical for new, sophisticated investors – Restricted stock and Options • Debt and Convertible Notes – Often used by early stage companies to avoid valuation – Not the best mechanism for aligning Founders and investors • Preferred Equity – Primary mechanism for sophisticated angels, angel groups and VCs 5 Equity Investment Vehicles
- 6. Pre-‐money $ 1,500,000 $ 2,000,000 $ 2,250,000 $ 2,500,000 $ 2,750,000 $ 3,000,000 $ 3,250,000 $ 3,500,000 Note $ 610,717 $ 610,717 $ 610,717 $ 610,717 $ 610,717 $ 610,717 $ 610,717 $ 610,717 Series A $ 1,500,000 $ 1,500,000 $ 1,500,000 $ 1,500,000 $ 1,500,000 $ 1,500,000 $ 1,500,000 $ 1,500,000 Option Pool (8.25%) $ 297,884 $ 339,134 $359,759 $ 380,384 $ 401,009 $ 421,634 $ 442,259 $ 462,884 Post-‐money $ 3,908,601 $ 4,449,851 $ 4,720,476 $ 4,991,101 $ 5,261,726 $ 5,532,351 $ 5,802,976 $ 6,073,601 Investor Ownership 54% 47% 45% 42% 40% 38% 36% 35% Management Ownership 46% 53% 55% 58% 60% 62% 64% 65% 6 Dilution -‐ Valuation’s relationship to Ownership
- 7. Capital Needs Time High Risk Low Risk Crystallize Ideas Demonstrate Product Early Scaling Growth Sustained Growth Market Entry • Raising money takes place over and over again because different lenders and investors match the current capital amounts and risk profile Risk vs. Return #TCNlive
- 8. • Understand the capital needed today, and the total capital needed to get to milestones (e.g. exit!) – Type of business (e.g. SaaS, Medical Equipment)? – Cost of getting to market? – Cost of ramping and running the business? • Compensate the management for getting to this point – What do they need for future motivation? – How many more senior people will be hired w/ options? • Look at comparable exits to understand likely exit multiple – Don’t forget to account for invested capital! • Is this a business investors can afford to invest in? 8 The Long View – Total Capital Requirements #TCNlive
- 9. • Valuation Based on Measuring…. – Sales (Multiple of revenue –P/R) – Net Income (P/E) – Cash Flow (EBITDA or Free Cash Flow) – Discounted Cash Flow (DCF) – Discounted Future Earnings – Net Worth or Book Value – Real Options, Black Scholes, etc. • NONE OF THESE APPLY TO STARTUPS! 9 Quantitative Methods – Valuing Mature Companies #TCNlive
- 10. Valuation Issues • Market Test & the Power of Auction: Leverage • Round size • Source (Angel, VC, Strategic etc.) • Total Capital Requirements • Terms vs. Pre-‐Money Price • Impact of Option Plans • Price less important than relationship • Positioning for future • Impact of Convertible Debt from F&F • On the “Promise” or the “Numbers” but not both!
- 11. Qualitative & Quantitative Factors • COMPARABLES – Valuation of deals recently completed in a similar space • KEY ASSETS OF THE COMPANY – Management: Commitment Knowledge & Experience – Intellectual Property & Defensibility – Financials & Time to Profit – Milestones Achieved – Revenue – Customers and Feedback – Barriers to Entry • FINANCING HISTORY / NEEDS – Funding to Date – Future Funding Needs – Last Round Post-‐Money Valuation – When was last round completed – Is the stock option pool sufficient • SIZE AND GROWTH OF MARKET – Current Size & Targeted Market • NOT the Total Available Market – Growth -‐ CAGR 11 #TCNlive
- 12. Early Stage Company Valuation Methodologies • Venture Capital Method (used also by many angels) – Future revenue x industry multiple x pro rata percentage x IRR = current value • Discounted Hypothetical Cash Flow / Net Present Value – Based on fiction • Chicago (DCF x probability tiers) – Same issue as above • Berkus (finger in the air) – Maximums per attribute (max $2.5m) • OTA/Payne – Comparison to average x weight – Helpful for biotech/cleantech • Risk Factor Method – Highly subjective – a more detailed version of Berkus Method • Opportunity Cost / Contribution Model – Based on sweat and lost alternative revenue • 1/3 Max rule – Treats angels like co-‐founders and weight cash versus sweat • Transaction Comparables – Hard to find like deals; general market trends may apply
- 13. Investor-‐Driven Method (aka Venture Math) • VALUATION -‐ Investor Requirements – Return rate required by investor (VC driver) – 10X to 20X – what is it? – Time Frame – 3-‐5-‐7 years – Any initial ownership goals – Valuation can be determined by working in reverse from exit valuation assuming hypothetical intervening dilution • VALUATION -‐ Investor Internal Dynamics – What you can sell to your syndicate partners – Size of fund and time since fund inception – Minimum Investment = meaningful percentage? 13 #TCNlive
- 14. Dave Berkus Method If it exists, then Add to Company value Sound idea $500k Prototype $500k Quality Team $500k Quality Board $500k Initial Sale $500k Valuation Range = $0 -‐ $2.5 million 14 #TCNlive
- 15. Bill Payne Method Factor Weight Rating (100% basis) Comment Management 30 125 On board, ex sales Size of Opportunity 25 115 Could be huge Product/Service 10 110 Disruptive platform Sales Channels 10 70 All foreign Stage of Business 10 125 Prototype works Other 15 80 All revs outside US 100% Weighted Average Rating = 1.0875 Pre-‐revenue Multiplier = $1.75 million Valuation = 1.0875 x $1.75 million = $1,903,125 15 #TCNlive
- 16. Risk Factor Summation Method (same company) Baseline $1.75 million Risk Factor Adjustment (-‐$500k to +$500k) Comment Management +$500k Done it before Stage +$250k Prototype works Funding Risk -‐$250k Int’l mkts tough Regulatory 0 Unregulated mkt Manufacturing +250k Nothing new Sales & Mktg -‐$500k Int’l mkts Competition +$250k Few in target mkt Technology +$250k Off shelf parts Litigation 0 None expected International -‐$500k All revs Int’l Reputational -‐$250k Int’l issues Exit +$250k Likely early $250k Valuation = $2.0 million 16 #TCNlive
- 17. Structure to allow value growth over time • Underlying Assumption – All business is a risk adjusted cash flow – Structuring a deal is “guessing” what the exit valuation will be • Valuation is a “Black Art” – Goal is to quantify a qualitative assessment, and then…. – Negotiate the deal so that everyone feels just a bit unhappy • Setting Deal Structure – MUST understand total capital requirements and likely capital sources – Need to understand option pool needs – Other economic terms include: liquidation preference, dividends, anti-‐ dilution adjustment and vesting of founder’s stock and option pool GOAL: Founders, Management, Early Investors and Later Investors all have great risk adjusted returns 17 #TCNlive
- 18. Angel Round Sizes Remain Steady Over Three-‐Year Period $0.00 $0.50 $1.00 2011 2012 2013 Median Round Size Mean Round Size *Angel rounds include angels & angel groups only $950K $857K $931K $610K $600K $600K $M
- 19. • Average valuation across all angel deals : $2.45million pre-‐money $350k invested 19 Angel Data 2013 #TCNlive
- 20. 20 The average pre-‐money valuation for a pre-‐revenue company across the US is $2.1 million Average Valuations -‐ Wisdom of the Angel Crowd #TCNlive
- 21. TCN FastTrack May 2014 Valuing an Early Stage Company Jeremy Halpern Nutter McClennen & Fish @startupboston jhalpern@nutter.com 617.439.2943 Paulina Hill Polaris Partners @paulinahill Christopher Mirabile Launchpad Venture Group @cmirabile