Venture Valuation

1. No track record:

   Short representative history of a company at the beginning of the lifecycle,

2. Limited financial resources: to finance investments, e.g. in R&D, product development, or

   marketing, Have the need to inject external cash

3. High importance of intangibles (e.g. know-how of management and employees), esp. for technology-oriented companies

4. Flexibility: High requirements regarding flexibility to cope with high dynamics

5. High level of risk,at the same time high potential returns

Generic Approach/ Fundamental Approaches

• Discounted-Cash-Flow Method

• Capitalized-Earnings Method

Context specific approaches/ Total Evaluation Procedures

• First-Chicago-Method

Generic Approach/ Market Valuation

• Industry Multiples

Context specific approaches/ Rules of thumb Method

• Rule of Ratios

• Equal split of shares between founders, management and VC

• Company value = investment * 3

• Complete negligence of company characteristics

• Separate valuation of company-specific components (e.g. attractive business idea, available prototype, highly-qualified founders, completeness of team etc.)

• Company value = Sum of value of components

• Examples: Morbitzer Method, Berker Method, or Kawasaki’s Law

• Many Business Angels only invest in companies with a valuation within a certain range (e.g.

  €1.5M and €3.5M)

• Lower valuations  limited growth orientation; higher valuations  lower probability of

  target returns

1. Venture Period: Typically lasts 3 to 7 years and ends with an IPO or acquisition. During this time

   period the company is raising money through rounds of VC investment.

2. Rapid-Growth Period: Typically lasts 3 to 10 years and ends when a company enters a period of

   stable growth and return on capital and operating margin approach industry averages (graduation).

3. Stable-Growth Period: The company is assumed to grow at a steady rate in perpetuity.

1. Risk Profile of the Investment:

   • Description: Start-ups, especially in their early stages, are inherently riskier due to unproven business models, uncertain market acceptance, and potential operational challenges.

2. Duration and Liquidity of the Investment:

   • Description: The time horizon for a VC's exit (e.g., through an IPO, acquisition, or secondary sale) impacts the expected return. The longer the capital is tied up, the higher the return VCs might seek.

1. Future Orientation:

   Explicit future orientation as future cash

   flows are taken into consideration (Projections are required)

2. Representation Adequacy

   Restricted representation adequacy to due difficult integration of intangible assets into the models / negative risk´s reflected by the WACC

3. Practicability

   Limited practicability as future cash flows have to be estimated which cannot be based on historic data

   Low level of complexity of NPV calculations

4. Acceptance

   Highest level of acceptance in the industry, most frequently applied method

   STILL: Future is hard to predict

1. Industry Mulitpliers

• Stock Exchange – Industry

  Multiples

• Expert Estimates

1. Peer Group Mulitples

• Comparables-Traded-Companies-Multiples

  • Similar-Public-Company

    Approach

  • Initial-Public-Offering Approach

• Comparable-Transactions-Multiples

• Growth companies usually operate in market niches for which nor industry multiples exist

• Broad range of multiples even within a specific industry

• Different phases of company lifecycles (young growth companies with a reduction)

• Industry multiples are usually focused on revenues and EBIT which are applicable to growth companies only to a limited extent

• Due to different growth rates and risk profiles, industry multiples are usually not representative

1. Step: Analysis of target company

   commercialcriteria – volumes,prices, qualities,warranties,maintenance,financial stability of supplier, etc

2. Step: Identification of comparable companies

   same industry or Determination of comparable companies

3. Step: Determination of market value of the target company

   Determination of market value & Determination of key

   company figures of comparables & Determination of

   multiples and market value of target

4. Step: Deductions / Supplements

   Illiquidity deduction; Package supplement or minority deduction

Enterprise value multipliers:

Measures the market value of all the securities of a company

• Financial

  —> Revenues; EBITDA or EBIT; Free Cash Flow; Capital Employed; Book Value of Total Capital

  Non-Financial

  —> Number of Customers

Equity/Market Value Mulitpliers:

Measures the market value of just the common stock

—> Net income, Earnings Growth, Cash Earnings, Book Value of Equity

• Average (Arithmetic Mean): Sum of a collection of numbers divided by the number of numbers in the collection  outliners on the high end can easily skew the averages

• Median: The number separating the higher half of a data sample from the lower half (never larger than the averages)

• Geometric Mean: Indicates the central tendency or typical value of a set of numbers by using the product of their values (as opposed to the arithmetic mean which uses their sum). The geometric mean is defined as the nth root of the product of n numbers

• Harmonic Mean (Subcontrary mean): The reciprocal of the arithmetic mean of the reciprocals

1. Future Orientation:

   • Criterion not 100% fulfilled

   • Market prices reflect estimates about future potential of the company

2. Representation Adequacy

   • Representation adequacy limited

   • Frequently, it is hard to find companies comparable for young growth companies

3. Practicability

   • Straightforward and fast procedure

   • Limited practicability of certain ratios (e.g. cash flow or earnings) for early stage companies

4. Acceptance

   • High level of acceptance, most frequently used method besides DCF approach

   • Reasons: Straightforward procedure and significant importance of market prices for valuation

   
   

• Key Idea:

  • Estimate the value of the company in a successful exit. Discount that value back to today at a very high rate.

• Main Elements:

  • 1. “Successful” exit valuation

    2. Target multiple-of-money

    3. Expected retention percentage

    4. Investment recommendation

The modified VC method, unlike the standard method, explicitly recognizes management fees and carried interest. VCs using the standard approach implicitly include costs in the target multiple of money (M). This approach is not ideal for two reasons:

• The approach mixes costs into the valuation step so that total valuation may differ across investors, even if the investors have the same expectations and value-added for the company.

• The approach groups many concepts into one number making precise analysis difficult.

The investment recommendation, using the modified VC method, is based on a comparison of LP cost to LP valuation.

• LP cost represents the gross cost of the investment considering management fees.

• LP valuation represents the value of the investment to LPs after the GP has taken carry.

1. Future Orientation:

   • Strong future orientation

   • A future value of the target company is

     determined, which is then discounted

2. Representation Adequacy

   • Strong focus on the perspective of the

     VC, the valuation is based on return

     objectives and risk preferences of the

     investors

   • No explicit consideration of intangibles

     and focus on negative aspects if risk

3. Practicability

   • Methods are based on limited number

     of data, leading to fast and simple

     valuations

   • Low level of complexity and high

     transparency of valuation

4. Acceptance

   • Methods were initially developed by VC

     industry and found widespread

     distribution, esp. VC method

   • Methods specifically suited for VC

     investments