Raiton Slides With Great Khosla Slide
- 1. VALUATION Real World Entrepreneurship – 2006 by Jack Raiton 1 OGI School of Science and Engineering
- 2. Valuation: Magic or Myth? • “It is a sign of an educated mind not to expect more certainty from a subject than it can possibly provide.” (Aristotle) • “Valuation requires an intermediate perspective between ignorance and certainty, involving the exercise of skill, experience and judgment” (Razgatis) 2 OGI School of Science and Engineering
- 3. An Icon’s Perspective “At a presentation I gave recently, the audience’s questions were all along the same lines: “How do I get in touch with venture capitalists?” “What percentage of equity do I have to give them?” No one asked me how to build a business!” Arthur Rock was a founder of Intel, an early investor in Apple, Teledyne, Scientific Data Systems, Air Touch Communications, … 3 OGI School of Science and Engineering
- 4. THE REAL DEFINITION OF THE VALUE OF AN EARLY STAGE COMPANY IS: “That point at which an investor’s fear is in equilibrium with his greed.” 4 OGI School of Science and Engineering
- 5. What is a Company Worth? • It’s worth what someone is willing to pay for it • It doesn’t matter what they paid for it… • Once you’ve paid for it, it’s yours! 5 OGI School of Science and Engineering
- 6. Macro Valuation Factors What drives valuations? • Liquidity, aka the “Exit” • The Economy • Public Markets – market multiples and the strength of the IPO market • M&A Activity 6 OGI School of Science and Engineering
- 7. U.S. Private Equity Performance (thru 2Q05) Early-stage VC historically beats all other asset classes 7 OGI School of Science and Engineering
- 8. 2004 VC Valuations by Company Industry Valuations Vary by Industry 8 OGI School of Science and Engineering
- 9. Valuation Shortcuts • “Small business owners often like to use the “MMM” method of business valuation. MMM, or Make Me a Millionaire, determines the asking price of a business by multiplying the number of owners by $1.0 million.” -Bryan Jamison, SMU BBA ’78 Wall Street Journal (circa 1985) 9 OGI School of Science and Engineering
- 10. Valuation Methods • Gut! • DCF (Discounted Seed Seedup Cash Flow) Start • Low single digits Later Stage • Comparable • Rules of Thumb transactions (M&A) • Convertible debt • Public market multiples • VC Method • P/E Analysis Early Seed e Maturce • EBITDA multiples Stag • Modified DCF Publi • Market comparables • Public market shares 10 OGI School of Science and Engineering
- 11. Valuation Methodologies • “Current Market Valuations” - More “art” than “science” - Comparable private market transactions - Usually correlates to changes in public market valuations • Discounted Cash Flow Analysis - Build financial model for 3 to 5 yr time frame - Project cash flows to the investors over investment time - Discount cash flows based on discount rate and time • Comparable Company Analysis - Select representative group of public companies - Sort by sector, size and growth rate - Determine appropriate valuation metrics: Revenue, Earnings, EBITDA 11 OGI School of Science and Engineering
- 12. The Art of the Deal – The “VC Method” 12 OGI School of Science and Engineering
- 13. VC Valuation Perspective Difficult to use established (late-stage/public market) valuation techniques for early-stage companies due to: • Volatility • Illiquidity • Long investment cycle • Complex/new technologies • Lack of transparency of private company data Last-stage valuation techniques more quantitative • Discounted cash flows • Public market comparables 13 OGI School of Science and Engineering
- 14. VC Returns • VC discount rates high to support portfolio losses (e.g. losses must be “baked into” VC models) • Game of “home runs” (Average portfolio: 10% - 10x or better returns 60% - low to average returns; 1x-4x 30% - fire-sales or written off • High risk/high reward game - Early-stage highest risk/reward ratio 14 OGI School of Science and Engineering
- 15. Funding to Milestones: aka “Old-Fashioned Venture Capital” Source: Vinod Khosla, Kleiner Perkins 15 OGI School of Science and Engineering
- 16. VC Model – Managing Risk 16 OGI School of Science and Engineering
- 17. Terminology 101 • IRR • Pre- and Post-money valuation 17 OGI School of Science and Engineering
- 18. Internal Rate of Return (“IRR”) • Internal Rate of Return – The discount rate that equates the net present value (NPV) of an investment’s cash inflows with its cash outflows – IRR measures the discount rate that sets NVP = 0 – Different from rate of return on investment (measure of market performance) 18 OGI School of Science and Engineering
- 19. IRR Example Example • 1st Year investment $1.0M • 2nd Year investment $2.0M • 4th Year investment $3.5M • Exit 5th Year return $20.0M • Total investment $6.5M IRR = 59% • Cash return $13.5M Multiple = 3x Excluding time weighting, produces a rate of return of 208% 19 OGI School of Science and Engineering
- 20. Pre- and Post-money Valuation • Post-money – Value of equity AFTER the new money goes in – Share price X fully-diluted shares outstanding AFTER new investment – Investment/POA (% ownership acquired) • Pre-money – Value of equity BEFORE the new money goes in – Share price X fully-diluted shares outstanding BEFORE new investment – Post-money - Investment 20 OGI School of Science and Engineering
- 21. Pre- & Post-Money Shares & Options 1.0M Price per Share X $7.00 (negotiated btwn co. and VC) Pre-Money $7.0M Pre-Money $7.0M (negotiated) 70% New Investment $3.0M 30% Post-Money $10.0M (value after new $) 100% 21 OGI School of Science and Engineering
- 22. Simple Model I How much do I need to own? • Solve for the required future value of my $3.5M investment to achieve 50% IRR – VC Required IRR 50% – Amount I’m investing $3.5M – Expected term to exit 5 yrs – Expected Net Inc in yr 5 $4M – Yr 5 Market Comp P/E 20 – Implied FV of Co in yr 5 $80M 22 OGI School of Science and Engineering
- 23. Simple Model How much do I need to own? ● Solve for the required future value of my $3.5M investment to achieve 50% IRR 1 2 3 4 6 – RFV = ((1+IRR)^Periods) X Investment – RFV = ((1+0.5)^5) X $3.5M $5.2 $7.8 $1.8 $17.7 $26.6 – RFV = $26.6M ● Therefore, I need to own $26.6M/$80M – 33% ● My investment offer to company might be $3.5M investment at $7M pre-money ($10.5M post-money) 23 OGI School of Science and Engineering
- 24. Simple Model II-A PE – 20x Exit = 5 years Earnings (Y5) = $10M VC required IRR = 50% VC investments = $10M Exit Value (Post-Money) 20 x $10M $200M = = $26.4M (1.5)5 7.59 Pre-Money = $26.4M - $10M = $16.4M $10M = 38% 26.4M OR 75.9M 75.9M = = 38% 20 x $10M $200M $10M x (1.5)5 = $10M x 7.59 = $75.9M 24 OGI School of Science and Engineering
- 25. Rules of Thumb • $5M Limit • Berkus Method – For a sound idea $1M – For a prototype +1M – For a quality management team +1M-2M – For a quality board +1M – For any roll-out, sales +1M $1M-6M • Role of Thirds – 1/3 to Founders – 1/3 to Management – 1/3 to Investors • $2.5M Angel Standard • $2-10M Internet Standard 25 OGI School of Science and Engineering
- 26. Some Take Aways • Entrepreneur should consider the following… – how much money will it take to really fly? – what milestones exist between push back and take off? – how much is required to achieve each milestone? – work backwards… • Valuations are negotiable particularly when… – you are a serial entrepreneur – there are numerous bidders – performance against milestones can be tangibly measured • Guy Kawasaki’s Law of PreMoney Valuation… – for every full time engineer (+$500,000) – for every full time MBA (-$250,000) 26 OGI School of Science and Engineering
- 27. Also Remember… • Venture capitalists don’t get rich by cutting tough deals • Entrepreneurs don’t get rich by taking highest offers • Don’t miss the forest for the trees! (sensitivity analysis) 27 OGI School of Science and Engineering