Start-up Valuation ClinicStart-up Valuation ClinicVenture Capital SeriesVenture Capital Series

Roydean Osman, Vice President SEED Investment – CRADLE Fund Sdn. BhdRoydean Osman, Vice President SEED Investment – CRADLE Fund Sdn. Bhd1717thth April 2008 April 2008

MSC Incubation Center, Multimedia University, CyberjayaMSC Incubation Center, Multimedia University, Cyberjaya

Agenda Agenda

Arts & Craft of ValuationArts & Craft of Valuation IntroductionIntroduction Valuation MethodologiesValuation Methodologies

Valuation methodologies used by Venture Capitalist (VCs)Valuation methodologies used by Venture Capitalist (VCs) Understanding the Venture Capital processUnderstanding the Venture Capital process What are you worth?What are you worth? First hand valuation by a VCFirst hand valuation by a VC Negotiation with VCsNegotiation with VCs Venture Capital MethodVenture Capital Method Financial EngineeringFinancial Engineering

Analyzing actual start-up companiesAnalyzing actual start-up companies

Where we are ? – Funding ECO System Where we are ? – Funding ECO System

Mat

urit

y

Expa

nsio

n

Growth & Profit

Fund

ing

Nee

ds

Point Zero

Production &

Commercialisa

tio

n

Market Entry

Production

Enhancement

New Markets

Scaling &

Expansion

Commercial

Success Pre IPO

Listing &

Go Global

Design &

Conceptualisatio

n

Idea Birth

Product Prototype

& Proof of

Concept

Se

ed

Pre

Seed

Gro

wth

Other Grants, SME Loans & Incubators, Government Incentives, Angels & Corp Investors

Project Financiers, Commercial Banks, Venture Capitals, Private Equity, Credit Guarantee Corporation, Leasing & Factoring Providers, Govt. Agencies

CradleInvestmentProgramme

Institutional & Foreign Investors, Public Funds, Merger & Acquisitions, Merchant Banks

MDeC

Arts & Craft of Valuation (1)Arts & Craft of Valuation (1) Differences between the entrepreneur’s/ private investor’s Differences between the entrepreneur’s/ private investor’s finance and corporate finance finance and corporate finance Entrepreneur’s / Private Investor’s FinanceEntrepreneur’s / Private Investor’s Finance

More volatileMore volatile ImperfectImperfect Less accessible than corporate capital marketsLess accessible than corporate capital markets Obtain source of capital differentlyObtain source of capital differently Companies are younger, more dynamicCompanies are younger, more dynamic Environment are more rapidly changing and uncertainEnvironment are more rapidly changing and uncertain Liquidity & timing are everythingLiquidity & timing are everything

Corporate FinanceCorporate Finance

Arena of public companies compete in well-established Arena of public companies compete in well-established capital marketscapital markets

Have access almost to everythingHave access almost to everything

Arts & Craft of Valuation (2)Arts & Craft of Valuation (2) In the VC eyes, determination of a company’s value is In the VC eyes, determination of a company’s value is elusive and it’s more art than scienceelusive and it’s more art than science

So, what’s a start-up company worth ?So, what’s a start-up company worth ? It all depends! It all depends! Very imperfect market capitalization unlike public Very imperfect market capitalization unlike public

companies where market capitalization is readily companies where market capitalization is readily determined. determined.

Entrepreneurial valuation are cash, time and risk.Entrepreneurial valuation are cash, time and risk.

Arts & Craft of Valuation (3)Arts & Craft of Valuation (3) Valuation MethodologiesValuation Methodologies

Net Present ValueNet Present ValueComparablesComparablesReal OptionsReal OptionsTurkish BazaarTurkish Bazaar

Adjusted Present ValueAdjusted Present Value First Chicago MethodFirst Chicago Method DCFDCF Golden HandcuffGolden Handcuff

Venture Capital MethodVenture Capital Method

Valuation Methodologies used by VCs (1)Valuation Methodologies used by VCs (1) Understanding the Venture Capital investment processUnderstanding the Venture Capital investment process

Biz Plans Biz Plans Kicks-InKicks-In

Products /ServicesProducts /ServicesConcepts/IdeasConcepts/IdeasAnalysisAnalysis

Entrepreneur Entrepreneur Analysis Analysis

Business/ Business/ VentureVentureAnalysisAnalysis

ConditionalConditionalTermsheetTermsheet

ApprovalApproval

Deal Sources

Due Diligence Deal Terms

Investment DecisionGo/No-Go

Screening Evaluation Continues

Valuation Methodologies used by VCs (2)Valuation Methodologies used by VCs (2)

VC Cash

Leadership(CEO)

Implementation(CMO, CTO,

CFO)Idea

Idea has limited value

Ability to implement project is most important

What are you worth ?What are you worth ?

Valuation Methodologies used by VCs (3)Valuation Methodologies used by VCs (3)

Cash Investment : Cash Investment : $3 million$3 millionProposed Investor Share: 66.7%Proposed Investor Share: 66.7%Post-Money Valuation : $ 4.5 millionPost-Money Valuation : $ 4.5 millionPre-Money Valuation : Pre-Money Valuation : $1.5 million $1.5 millionExit Valuation (Yr 5): Exit Valuation (Yr 5): $30 million (PAT)$30 million (PAT)Return to Investor (IRR):Return to Investor (IRR): 46%46%Cash-on-Cash Return InvestorCash-on-Cash Return Investor 6.7x6.7x

First hand valuation by VCs – expected Return on InvestmentFirst hand valuation by VCs – expected Return on Investment

Valuation Methodologies used by VCs (4)Valuation Methodologies used by VCs (4) Negotiation with VCsNegotiation with VCs

$

Com

pany

Val

ueCo

mpa

ny V

alue

VC Maximum ValueVC Maximum Value

Entrepreneur Minimum ValueEntrepreneur Minimum Value

Negotiating SpaceNegotiating Space

PE Multiples

Seed

Early

Expansion

Mezzanine

1 to 2x

2 to 3x

4 to 5x

20 – 50x

Valuation Methodologies used by VCs (5)Valuation Methodologies used by VCs (5) Venture Capital Method (1)Venture Capital Method (1)

Post-money valuation:Post-money valuation: The valuation of the company The valuation of the company immediately after a round of investment is closed. immediately after a round of investment is closed.

Pre-money valuation:Pre-money valuation: The valuation of the company just The valuation of the company just before closing a new round of investment, including the value of before closing a new round of investment, including the value of the idea, the intellectual property, the assembled management the idea, the intellectual property, the assembled management team, and the opportunity.team, and the opportunity.

Terminal value:Terminal value: The valuation of the company at exit; that is, The valuation of the company at exit; that is, the proceeds of the sale of the company via a merger or the proceeds of the sale of the company via a merger or acquisition or an initial public offering and at which time the acquisition or an initial public offering and at which time the investors' ownership can be liquidated.investors' ownership can be liquidated.

ROIn:ROIn: The cash-on-cash return on investment expected for such The cash-on-cash return on investment expected for such an investment in the year of the harvest, or exit. This ROI is an investment in the year of the harvest, or exit. This ROI is commonly expressed as a multiple of invested cash—that is, 10x, commonly expressed as a multiple of invested cash—that is, 10x, for example—regardless of the time since investment (n years).for example—regardless of the time since investment (n years).

If the terminal value of a company seeking seed/start-up capital is estimated to be $60 million and we assume the stage of the company is appropriate for investors to expect 30x ROI in year of harvest, then the post-money valuation of this company can be estimated at $2 million. If the required investment is $0.5 million, then the pre-money valuation would be $1.5 million.

Valuation Methodologies used by VCs (5)Valuation Methodologies used by VCs (5) Venture Capital Method (2)Venture Capital Method (2)

1.1. Identify the company’s forecasted net income within n years up to exit year. Estimate Identify the company’s forecasted net income within n years up to exit year. Estimate normally based on sales and margin projections.normally based on sales and margin projections.

2.2. Assign appropriate P/E ratios to the company based on current multiples for companies Assign appropriate P/E ratios to the company based on current multiples for companies within similar economic characteristics.within similar economic characteristics.

3.3. Derived at a Terminal Value . E.g. Terminal Value (t) = Net Income x P/E ratio.Derived at a Terminal Value . E.g. Terminal Value (t) = Net Income x P/E ratio.4.4. Terminal Value can be discounted. Normally VCs discount rates range from 30% - 80% due to Terminal Value can be discounted. Normally VCs discount rates range from 30% - 80% due to

the risks involved in the type of investments.the risks involved in the type of investments.

Required InvestmentRequired InvestmentOwnership (%) = Ownership (%) = Required Required Total Terminal Value Total Terminal Value

Ownership Required (%)Ownership Required (%)New Shares =New Shares = 1 – Ownership Required x old shares1 – Ownership Required x old shares

Valuation Methodologies used by VCs (6)Valuation Methodologies used by VCs (6) Financial EngineeringFinancial Engineering To overcome valuation or incentive issues, VC’s will engage in To overcome valuation or incentive issues, VC’s will engage in ‘financial engineering’‘financial engineering’

DebtDebtPreferred SharesPreferred SharesPreferred Convertible SecuritiesPreferred Convertible SecuritiesMixed Debt and EquityMixed Debt and EquityRatchets or Clawbacks (Downside for Investor, Upside for Ratchets or Clawbacks (Downside for Investor, Upside for Entrepreneur)Entrepreneur)Liquidation preferencesLiquidation preferences

Fundamentally challenges notion of pre-money value, as values and Fundamentally challenges notion of pre-money value, as values and returns become contingent on future eventsreturns become contingent on future events

Analyzing an actual start-up Analyzing an actual start-up VCs Valuation Interactive – (1)VCs Valuation Interactive – (1) To review start-up Income Statement 5 year projectionTo review start-up Income Statement 5 year projection To review start-up Cash Flow Information for 5 year To review start-up Cash Flow Information for 5 year projectionprojection

NOTE : Please have all the above ready.NOTE : Please have all the above ready.

Coming up with valuation based on Venture Capital Coming up with valuation based on Venture Capital approach.approach.

Analyzing an actual start-up Analyzing an actual start-up VCs Valuation Interactive – (2)VCs Valuation Interactive – (2)Income Statement (5 year projections)Income Statement (5 year projections)

Year 1 Year 2 Year 3 Year 4 Year 5RevenueCost of Goods SoldGross RevenueGrowth (%)Gross Margin (%)Profit After Tax

Income Statement Information (Yr End)

Analyzing an actual start-up Analyzing an actual start-up VCs Valuation Interactive – (3)VCs Valuation Interactive – (3)Cash Flow Information (5 year projections)Cash Flow Information (5 year projections)

Year 1 Year 2 Year 3 Year 4 Year 5

Fund RequirementFund to Raise

Beginning Cash Balance 0 0 0 0 0Fund Utilization 0 0 0 0 0Cash Invested in Marketable Securities 0 0 0 0 0Return on Invested Cash 0 0 0 0 0Ending Cash Balance 0 0 0 0 0

Cash Flow Information (Yr End)

ClosingClosing Determined methodologies used by venture capitalists and Determined methodologies used by venture capitalists and professional investors to estimate the value of a companyprofessional investors to estimate the value of a company

Understand how equity proportions are allocated to investorsUnderstand how equity proportions are allocated to investors

Analyzing a startup financingAnalyzing a startup financing

VCs are active investors and bring more to the deal than just VCs are active investors and bring more to the deal than just money: money:

o spend a large amount of time, o spend a large amount of time, o reputation capital, o reputation capital, o access to skilled managers, o access to skilled managers, o industry contacts, network, o industry contacts, network, o and other resources. o and other resources.

A large discount rate is a crude way to compensate the VC for A large discount rate is a crude way to compensate the VC for this investment of time and resources. this investment of time and resources.

Thank You !Thank You !roydean@cradle.com.myroydean@cradle.com.my roydean.osman@gmail.com