Slide 1
Class 9 Notes
Valuation
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 2
Agenda
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Midterm Grades
Homework due tonight
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Winning Angels - valuation
ContentSoft recommendation
Reflecting…
Recommendations
Valuation
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 3
Reflecting…
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What investors do – raise, invest, harvest
Angels vs. VC’s
History and trends
Fund economics
Investment models
Deal sourcing and screening (filters)
Deal evaluation (the entrepreneur and the pitch)
Due diligence
Deal Structure
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70-397 Venture Finance
Valuation
Contracts and terms
Fall 2002
© Andrew W. Hannah
Slide 4
Investment Recommendations
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Goals
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Present a clear picture of the company, product and
opportunity
Present the diligence results in a manner that supports the
recommendation
Basis for the recommendation
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70-397 Venture Finance
Markets – size, growth rate, key features
Competition – direct and indirect, key features, strength
and weaknesses
Comparables – business model, financials, valuation
Valuation – how much? Exit and when?
Fall 2002
© William Hulley and Andrew W. Hannah
Slide 5
Investment Recommendations (Cont.)
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What is included in the company’s plan?
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The Overview – a presentation of the company’s plan
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70-397 Venture Finance
ContentSoft Example
The Diligence
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Market
Customer
Product
Management
Competition
Competitive Advantages
Financial Overview
Market
Competition
Comparables
Valuation
Recommendation – yes or no and why
The diligence memos (as appendices)
Fall 2002
© William Hulley
Slide 6
Valuation
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 7
Why Are Companies Worth What
They Are Worth?
ICGE, Ariba, Cisco
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 8
The Fundamentals of a Stock Price
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Share Price= Company Valuation / # of shares
Company Valuation = Share Price * # of shares
Share price is what we follow but what is really
fluctuating is valuation
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 9
So What Is Valuation Anyway?
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Theory versus practice
Theory : Discounted Cash Flows
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Discounted = Net Present Value
Cash Flows = Expected cash inflows less
expected cash outflows
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70-397 Venture Finance
Inflows = Cash from customers
Outflows = Costs to run the company
Fall 2002
© Andrew W. Hannah
Slide 10
Present Value Basics
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Future Value
You have $1
I guarantee you 10% interest for three years
(or inflation is at 10%)
Your value:
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Year 1: $1.10
Year 2: $1.21
Year 3: $1.33
You are indifferent!
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70-397 Venture Finance
$1.33 in three years
$1.00 today
Fall 2002
© Andrew W. Hannah
Slide 11
Simple NPV
So….
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Discount Rate = 10%
Time = three years
Future Value = 1.33
What is the NPV?
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 12
Back to Valuation…
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Valuation (NPV) = Discount Cash Flows over some
period of time
Discount Rate = 100% (cost of capital)
Year
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2
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FCF
$10
$20
$30
PV Fctr
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2
4
PV
$10
$10
$7
NPV
$52.97 vs. $27
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 13
The Real Calculation
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NPV = Discounted Cash Flows (DCF)
+ DCF year ‘n’ / (cost of capital – growth rate)
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Terminal Value = the new part
Discount rate = cost of capital
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Rate you could borrow/obtain money at to grow your
business
Lower the risk the lower the cost of capital
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Low risk = Bank debt (8% or Prime + x%)
Higher Risk = Public Offering (20%)
Highest Risk = Venture capital (50%? 75%? Higher)
Growth rate = expected annual increase in cash
flows
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 14
NPV Formula – Cleaned Up
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NPV = Future Value/ (1 + d) ^t
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Future Value = cash flow
d = discount rate
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Reflects cost of capital
Risk free rate + risk factor
t = time (“years”)
Terminal Value: cash flows in perpetuity = [FCF (year
n)/ (d – g)]/ (1 + d) ^ n
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70-397 Venture Finance
g = growth rate of FCF in perpetuity
Fall 2002
© Andrew W. Hannah
Slide 15
Valuation Example
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Discount Rate = 10%
Growth Rate = 4%
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Year
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FCF
PV Fctr
PV
NPV
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$10
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$10
$466.19
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$20
1.1
$18.18
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$30
1.21
$24.79
TV
$30
1.21
$413.22
TV= [$30/(10% - 4%)]/ 1.21 = $413.22
(Revisit ICGE and CSCO)
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 16
In the End..
Valuation is based on expectations:
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70-397 Venture Finance
Are cash flow projections realistic
Growth rates
Risk of execution (discount rate)
Sustainable position
Ability to innovate
Fall 2002
© Andrew W. Hannah
Slide 17
Valuation Methods For
Entrepreneurial Companies
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Discounted cash flow?
Multiples of public companies and sale of private
companies:
Sales
Earnings (current/future)
Customers?
Negotiation
Remember: discount rates = risk and required rate of
return = cost of capital
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 18
Valuation Methods By Stage
Pre-Money
Use of Proceeds Determinant
Key MV Drivers
“Plan in Hand”
Proto-type
Research
Formulaic ($2 $6 M)
Founder
Experience
Post-Seed (“A”)
Proof of concept
Negotiation
($8 - $15)
Tangibles/
Intangibles
Early Growth
(“B”)
Mgmt Team
Customers
Negotiation
($15 - $30M)
Tangibles/
Intangibles
High Growth (“C”,
“D”)
Expansion
Acquisition?
Comp Driven
($45 - $55M)
Public/Private
Transactions
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 19
What Makes a Difference?
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The team’s experience
Stage of development
Customers
Protectable IP
Economic conditions
Size of the opportunity
Other
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 20
Valuation Strategy
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Entrepreneurs must triangulate (dcf and
public & private multiples)
VC’s:
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Discount projections
Look for 55% discount factor
Look hard at public and private multiples
Entrepreneurs best strategy: create an
auction
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 21
Pre- and Post-Money Valuation
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Pre-money valuation = value of the company before
the investment round
Post-money valuation = value of the company after
the investment round
Example
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70-397 Venture Finance
You own 50% of a company
Pre-money valuation = $10 million
You are raising $5 million
What is the post-money valuation?
What is your new ownership percentage?
Fall 2002
© Andrew W. Hannah
Slide 22
Next Week
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Contracts and Control
Diligence Card “B” – comparables
WA: 179 – 222 (this is different than the syllabus)
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah