Politics of Valuation

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Politics of Valuation Presented by Steven R.
Kopits March 2002
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Agenda

• Valuation Measures
• Calculating Your Worth

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Value Function for a Fund
CASH OUT
CASH IN
TIME
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Two Valuations

• Business Potential
• Based on research and analysis
• Share of the Company
• Results of negotiation with entrepreneur

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Negotiating Space

VC Maximum Value
Negotiating Space
Company Value
Entrepreneur Minimum Value
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Valuation Techniques

• Price/Revenues
• Price/Earnings
• Price/EBITDA
• Price/Book Equity
• Price/Net Assets
• Price/Comparables
• DCF

• Price/Cash
• Price/SWEQ
• Price/SWILL
• Tradition
• Golden Handcuffs
• Turkish Bazaar

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Valuation Measures

• Price/Earnings
• Requires positive earnings
• Easily distorted/manipulated
• Ignores potentially important cash flow
  considerations
• Price/EBITDA
• EBITDA earnings before interest, taxes,
  depreciation and amortization
• Measures of operating cash flow which must be
  positive
• Ignores Capex issues

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Valuation Measures

• Price/Assets
• Assets-liabilities, all measured at market value
• Requires assets start-up may have expensed
  organization building gtgt little of no real assets
• Price/Book Value (Equity)
• Requires history of profitability
• Backwards looking
• Easy to measure
• Does not capture intangibles

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Valuation Measures

• Price/Cash Invested
• Most conservative measure of resources actually
  invested in a project
• Values benefit of labor at zero
• Generally floor for discussions with VC
• Price/Cash Invested Sweat Equity (SWEQ)
• Recognizes labor
• Does not recognize upside potential of project
• Lower limit of tasteful negotiation

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Valuation Measures

• Price/Cash Invested Sweat Equity Goodwill
  (SWILL)
• Recognizes cash, labor, and at least some upside
  potential
• Goodwill may be tricky to measure
• Tradition
• Established valuation range for company by stage,
  regardless of industry or specific merits of a
  given team or proposal
• Durable measure, widely used

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Valuation Measures

• Discounted Cash Flow (DCF)
• Most integrated and complete of all valuation
  measures
• Highly sensitive to assumptions
• Yields highest valuation
• Turkish Bazaar
• Unconstrained negotiation
• Indirect benefits may feature prominently

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Valuation Measures

• Golden Handcuffs
• Minimum share given to entrepreneur to maintain
  his medium-term (3 year) commitment to the
  company
• 3-4 years salary equivalent
• In line with Traditional method

VCs should not enter a deal below the Golden
Handcuffs threshold measure
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Measures by Stage
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Early Stage Valuation Biases

High
Comp.
G. Handcuffs
SWILL
Med.
DCF
P/A
Low
Tradition
P/E
P/BV
P/R
SWEQ
Zero
Cash Inv.
Future
Present
Historical
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Early Stage Indicative Values
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Developing IRR Hurdles

• Of 10 early stage investments all with 7-10x
  cash-on-cash return requirements

• EVCA average for early stage funds 13-22 IRR

Substantial project attrition and overhead costs
reduce high expectations to modest returns
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What Are You Worth?
Leadership (CEO)
Ability to implement project is most important
VC Cash
Implementation (CMO, CTO, CFO)
Idea
Idea has limited value
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Key Points

• Entrepreneur must be aware of
• Range of valuation measures which will be applied
  to the company
• Which valuation measures are relevant
• The negotiating implications of various
  measurement techniques

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Case Study

• Janos and Henry are both 27 years old and have
  founded a company in their spare timeeach still
  has his full time job. They put 30,000 into
  the company, but far more in cash (to avoid
  taxes). They have also put in almost all their
  spare time for the last 18 months. Their company
  is now producing about 100,000 a year in
  revenues. They believe the company could grow
  rapidly with an injection of 1 million.
• How big does the company have to grow to attract
  venture capital investment?
• How much of the company will they own?
• What method will the venture capitalist use to
  knock-down the valuation?

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Contact Detail

• Steven Kopits,
• mobile [phone]
• email steven.kopits_at_gmail.com