So there have been a flood of emails from readers about the Valuation I post. Seems like people want to know when to apply what valuation technique and what techniques are best for early stage companies. So it looks like this short two post series on Valuation is going to be several posts. Here is a paraphrase question from one reader's comment:
Is there a different set of valuation criteria for Internet Technology products?
Let me first again say that the practice of valuing a company is more art than science. When you start a company and plan for liquidity, it is wise to come up with an exit value of the enterprise. Using as many valuation models as possible and running sensitivities on those models is beneficial. Utilize trading multiples, merger multiples, as well as discounted cash flow models. In theory if your model is correct, it should not matter what point in time you are relative to the liquidity date. Obviously, though, we all know that the closer your company is to the sale or liquidity event, the more realistic your valuation will be.
Utilizing several models is wise because the marketplace for companies is extremely inefficient and illiquid. Even once you reach the public markets, while your stock is liquid, the marketplace for transactions is still inefficient. Because of this inefficiency, different models will cover as many bases as possible.
Keep in mind the basis of valuation - something is only worth something if there is a buyer willing to pay it! So do not lose sight that at the end of the day it does not matter what the heck is in your valuation binder. There will be a buyer and you will need to settle on a price. He will have one in mind, you will have another in mind. Somehow you need to come to terms and convince each other on valuation. Perhaps one of your models will do the trick.
For Internet Technology, there is a different set of criteria. There is added risk. There are unknown trading or merger multiples. Even the known multiples may be bogus because the buyer was Google or Yahoo or MSFT. This is not your traditional industry. Cost of acquiring or keeping a customer is unpredictable. Churn isn't known for a new industry. All of these variables should be included in any model.
Every investment firm will probably have a different set of valuation criteria. Most vary according to their "risk" or "fudge" factor discount percentage.
Here is an example of a basic crude valuation of a startup:
2011 Projections (Liquidity Date)
Projected After Tax Earnings of 5 mm
Projected Valuation 50 mm based on multiples, merger activity, industry standard P/E ratio
20% Discount Rate Applied
Year 1 Valuation 20.48 mm
Year 2 Valuation 25.6 mm
Year 3 Valuation 32 mm
Year 4 Valuation 40 mm
Year 5 Valuation 50 mm
Now based on this crude analysis that does not take into account any financing events, it seems that in Year 1, you have a valuation of 20.48 mm. There is an added risk of a private company. There is an added risk of unproven technology. There are lots of other added risks if this company is in a different country: currency risk, geopolitical climate risk, foreign market risks.
So on top of that valuation there will be a discount applied to take into account these risks. This discount will vary according to the types of risks we are talking about.
I am sure I will get a slew of emails with more questions. Keep in mind that value and valuation is in the eye of the beholder.
How to put a value on a Web 2.0 company for investors.
Example Site: (we do own this URL)
50,000 Daily Visitors.
100,000 confirmed Emails for signups
$5,000 a month income.
How would put a value on Each User? To put a value at 15x Income doesn’t seem right.
In your opinion what is correct way to put a value on a Internet Company?
$5,000 Monthly income * 12 Months gives $60,000 Yearly Income with a 15x Multiple means a $900,000 Valuation
Posted by: Anthony | December 22, 2006 at 08:05 AM