Valuation of start up companies

Valuation of Start-Up Companies
November 2nd 2017
César García de Roda
Director of Valuation Services
MAZARS Financial Advisory
cesar.garcia@mazars.es

2
Introduction
• Topics:
• Valuation of Start-Up Companies
• Contents:
1. How we define a Start-up?
2. The different stages of a Start-up
3. Why is valuation important?
4. Due Diligence of Start-Ups. Which is the focus?
5. Financing rounds and investor types
6. Valuation Methods
7. Recap
Time permitting:
“Investment in Start-Ups in Spain 2016”

4
How we define a Start-up?
A Start-up is ……….
…….a NEW company / NEW business
That offers ……….
…….INNOVATIVE products and/or services
With ………….
…….high GROWTH potential
Start-ups generally refer to “technology driven” companies although we can find start-
ups in other fields where technology is not the key driver.

5
The management of Growth
• Growth potential is the main characteristic of a Start-up, so a new
local shop or a new restaurant that offers new products can not be
considered as a Start-up. It has to be a Scalable Business
• Growth is linked to investment, and investments are linked to
financing needs
• However, in their first phase of development, start-ups are not able
to finance their growth as they do not generate cash, instead they
burn it at a very fast speed
• There are different development phases in the life of a Start-up,
each of them with different financing needs
• One of the first challenge of the entrepreneur is to correctly
identify the financing needs and to find the right source of
financing for that stage

The different stages
of a Start-up
02

7
The different stages of a Start-up
time
$
€
0
SEED
STAGE
EARLY
STAGE
GROWTH
STAGE
EXPANSION
STAGE
EXIT
Valley of
Death

8
Each stage is different and needs different financing solutions
time
$
€
0
SEED
STAGE
Characteristics
• Development of the idea by the entrepreneur
• Analysis & studies (market, client, product…)
• Challenge: Business Plan Beta
• Seek for third party advice: parents, friends, work mates, industry experts
• Small team: sometimes only entrepreneur + tech guy
Financing needs and solutions
• No revenue but high initial costs (first prototypes, studies, travel, etc.)
• Team has no salary
• Financing by entrepreneur (savings), friends and family
• Some Business Angels (BA) also invest in Seed stages

9
time
$
€
0
SEED
STAGE
Characteristics
• Product/Service has been developed
• Challenge: develop business and enter the market
• New tasks: marketing & sales
• New team is needed: fixed salary vs % equity
• First revenue (still low) but high costs (team, marketing,
offices, production, development, etc.)
• Financing needs increase substantially
• Business Angels (BA), incubators, accelerators,
crowdfunding, crowdlending and public agencies are
present in early stage investments
EARLY
STAGE

10
time
$
€
0
SEED
STAGE
Characteristics
• Product is demanded by the market so is
time for growth and increase market share
• Main challenge for the entrepreneur is time
management: team, competitors, product,
finance, innovation, clients, legal, suppliers..
• Recurrent revenue but cash flow not
enough to finance all the growth
• Visibility on business model and cash flows
is higher so its time for Venture Capital (VC)
EARLY
STAGE
GROWTH
STAGE

11
$
€
0
EXPANSION
STAGE
EXITSEED
STAGE
EARLY
STAGE
GROWTH
STAGE
Characteristics
• Growing flow of revenue, solid client
base and stable workforce
• Main challenge: expand to new
markets and new segments
• Risks: Is the organization prepared?
• Growing revenue and generation of
cash flows is key to give confidence and
attract new investors
• Expansion is very cash demanding
• New VC and specialized Private Equity
(PE) are called to be the right investors
time

12
$
€
0
Characteristics
• If the company is in the EXIT stage we are
talking about a SUCCESS STORY!
• The company is generating important cash
flows and might be of interest to other
companies or investors. It’s time to make a
decision:
• Do we keep growing? Do we look for new
opportunities (new products, new
markets, new segments)? Same team?
• Do we cash out? IPO, Corporate,
Secondary market (PE)
EXPANSION
STAGE
EXITSEED
STAGE
EARLY
STAGE
GROWTH
STAGE
time

Why is valuation
important?
03

14
Why is valuation important?
SEED
STAGE
EARLY
STAGE
GROWTH
STAGE
EXPANSION
STAGE
EXIT
• The valuation of the company and the amount to invest determine the % of the share
capital that an investor will obtain when investing in the company, but also the new %
of ownership of the entrepreneur and the existing shareholders at that time
• At least one valuation of the company per stage will be needed
• Sometimes there are more than one financing rounds per stage, so easily a Start-up is
subject to external valuations more than 10-20 times in its life!
time
100%
~0 €
€ millions
Small %

15
Valuation issues in Start-ups
• No history
• Small or no revenue and operating losses
• High risk do to the uncertainty of the future development
• Depending on private investors and many financing rounds
• Illiquidity of the investment
• Many of the Start-ups don’t survive: between 75%-80% of them
fail before year 5,and 90% before year 10
• So… Why investing in Start-Up companies?
• Those companies that complete all stages show exceptional
returns and clearly compensate the risks taken by the investors
and the losses from other failed investments
• Diversification of investments is very important for investors

16
Two Success Stories: Spotify & UBER
• October 2008
• Valuation $100m - > Series A financing raises $22m
• In the following 7 years there where 7 investment rounds
• Last of the 7 investment rounds:
• Valuation $8bn -> Series G financing raises $526m
• 80 times the valuation obtained in 2008
• February 2011
• Valuation $160m - > Series A financing raises $11m
• July 2015
• Valuation $50bn -> Series F financing raises $1bn
• +800 times the valuation in 4 years

Due Diligence of Start-Ups
Which is the Focus?
04

18
Which is the focus?
When acquiring a mature company the investor focuses in the classical Due
Diligence ….
• Financial & Tax
• Legal & Labour
• Other (environmental, commercial, operating…)
When we are talking about Start-ups, specially in seed and early stages, the focus
is completely different, and there are 3 aspects that are key for the investor to
secure the value of the company:
1. Founding partners (entrepreneurs)
2. Product and business model
3. Market

19
1. Founding partners (entrepreneurs)
• In Pre-Sales stage companies, investor’s bet is on the founder and his/her idea
• So, it is of maximum importance to get to know the founder:
• Is he/she committed with the project? How?
o Did he/she left his/her previous job to work exclusively in the project? Or just in the weekends?
o Has he/she or his/her family invested in the project? If yes, how much?
• Is this his/her first project?
o If no, were the other projects successful? Why or why not?
2. Product and business model
• Full understanding of the product
• Prices, target users..
• Business model
• Is a capital intensive business?
• Which is the cost structure of the industry? Are there economies of scale?
3. Market
• Size of the market: current size and growth opportunities
• Competitors and entry barriers

20
Useful tool: The Canvas Model

Financing Rounds &
Investor Types
05

23
Financing Rounds and Investor Types
• Start-Ups financing is far more developed in countries like US &UK
• In Spain and other EU countries, the number and variety of financial
investors and instruments available for the first stages of
development of the Start-Ups has increased a lot in the last 10 years:
SEED
STAGE
EARLY
STAGE
GROWTH
STAGE
EXPANSION
STAGE
• FFF (Friend, Family & Fools)
• Accelerators / Incubators
• Crowdfunding & Crowdlending
• Business Angels (BA)
• Public Agencies: ENISA, CDTI
• Venture Capital (VC)
• Series A, B, C …
• Private Equity (PE)
• Investment banks (IB)

24
FRIENDS, FAMILY & FOOLS …..
• Individuals that are close to the founder/entrepreneur
• They are the first ones to invest and their motivation is more
confidence and friendship than a financial return
• Friends and Family are always the first source of financing as they
are unconditional investors and proud to participate in the project
• The third “F” (Fools ) includes work colleagues, ex-bosses, old
teachers or any one close to the founder
• Each investment is not very big, but enough for the first steps of the
project
• A good number of FFF is also a very positive signal to other
investors to come as the founder is showing that people trust him

25
ACCELERATORS & INCUBATORS
• They can be of great help to the founder at the start of the project
• These platforms offer support to entrepreneurs in the form of workplaces,
project assessment (mentorship), elaboration of the business plan and legal &
financing assessment
• In exchange of 5-10% of capital
CROWDFUNDING
• Reward Based: the entrepreneur offers a reward in the form of product and/or
service according to the amount of the investment
• Equity Based: the investors get a participation in the equity of the Start-Up and
they become shareholders
CROWDLENDING

26
BUSINESS ANGELS
• Individuals that take their own investment decisions and invest in
projects that are of interest according to their own judgement (e.g.
Canvas Model)
• BA normally support the company also with contacts, knowledge,
experience and time
• BA investment amounts vary, but typically move in the range of
75.000€ - 400.000€
• Sometimes a group of BA work and invest together (Angel
Syndicates)

27
VENTURE CAPITAL (VC)
• VC are generally specialized investors by industry, investment size
and investment round (series)
• Series A
• Amount: between €2m and €5m (Europe)
• Goal: financing of the initial growth stage
• Characteristics: still high risk profile in product, team and organization
• Series B
• Amount: between €6m and €10m (Europe)
• Goal: financing of expansion and value creation
• Characteristics: need to grow and continuous product development

28
VENTURE CAPITAL (VC)
• Series C
• Amount: from €10m to hundreds (Series D, E, F, G…)
• Goal: financing of acquisitions, improvement and product
development
• Characteristics: mature companies, valid business model, large client
base
• Different type of VC depending on the amount to invest.
• Also co-investment of VCs, Private Equity and Investment Banks
EXIT
• End of the Road: IPO, sale to a bigger company

30
Sources of Value
• Free Cash Flow: the more FCF a company
generates, the HIGHER the value of the
company is
• Growth: the higher the growth of that FCF
is, the HIGHER the value of the company
• Risk: the more risky (uncertain) is the
generation of FCF, the LOWER the value of
the company
Being simplistic, there are 3 sources of value:

31
Valuation is more difficult in the initial stages…
time
$
€
0
SEED
STAGE
EARLY
STAGE
GROWTH
STAGE
EXPANSION
STAGE
EXIT
“The stage & the information available will determine our valuation approach”
STABLE &PREDICTIBLE
SOLID POSTION/STABLE MARKET
SUCCESFUL PRODUCT
CONSIDERABLE ASSET BASE
EXPERIENCED TEAM
DEBT & EQUITY FINANCING
LOWER RISK
LOW VISIBILITY
NEW MARKET TO DEVELOP
NEW PRODUCT/UNCERTAIN SUCCESS
UNEXISTING/FEW ASSETS
NEW TEAM
MOSTLY EQUITY FINANCING
HIGH RISK (UNCERTAINTY)
CASH FLOWS
MARKET
PRODUCT
ASSETS
MANAGEMENT TEAM
FINANCIAL STRUCTURE
RISK

32
Risk & Value
time
R
I
S
K
0
SEED
STAGE
EARLY
STAGE
GROWTH
STAGE
EXPANSION
STAGE
EXIT V
A
L
U
E
0

33
One important valuation concept
PRE-MONEY VALUE vs POST-MONEY VALUE
Those two concepts have to be clear before starting a new round of financing
• Pre-Money Value:
 Value of the Start-Up BEFORE the investment of the VC (or any investor)
• Post-Money Value
 Value of the Start-Up AFTER the investment of the VC
Example
• A Start-up needs €100.000 and a VC is ready to invest that amount for the 20% of the capital
• This means that the value of the company, once the VC has invested the amount of €100.000
will be €500.000, where €100.000 is the 20% of €500.000
• This valuation is the Post-Money Value, after the investment of the VC
• The Pre-Money Value, before the investment of the VC, is €500.000-€100.000= €400.000

34
Some valuation methods: a NON-exhaustive list
time
SEED
STAGE
EARLY
STAGE
GROWTH
STAGE
EXPANSION
STAGE
EXIT
Berkus Method
Discounted Cash Flows
(DCF)
Risk Factor
Summation Method
Comparable
Transactions
Venture Capital
Method
First Chicago
Method
Scorecard Valuation
Method

35
Valuation Methods
BERKUS METHOD
• Developed by Business Angel called Dave Markus in the 90’s
• This method shows a rule to estimate value of a company in a PRE-SALES stage
• The method is based in the believe that the company will generate $20m sales on Year 5.
• If the answer is affirmative, then you have to value according to 5 items
• In this context, the maximum value of a Start-Up company without sales is $2m while if
there are some initial sales is $2,5m
• This method can be useful for entrepreneurs to have an idea of the pre-money value of the
business in a seed/early stage. Obviously is a very subjective method but could be useful to
start negotiations
• Values were prepared for the US market but can be adapted to others
Item Description Value
1 Quality of the idea 0-$500k
2 Existence of a prototype 0-$500k
3 Quality of the team 0-$500k
4 Strategic relationships 0-$500k
5 Launch of product and first sales 0-$500k
BERKUS METHOD
https://berkonomics.com/?p=131

36
Valuation Methods
RISK FACTOR SUMMATION METHOD
• This method is similar to Berkus Method and is
also designed to estimate the value of a
company in a PRE-SALES stage
• The method starts by defining an initial pre-
money valuation as an average of similar
companies in the industry. This information
can be obtained in websites such as: “Angel
Capital Association”
• The initial valuation is adjusted (positively or
negatively) according to 12 criteria (risks
factors) that are valued according to their
perceived risk level
• This method forces investors to think about
the various types of risks which a particular
investor must manage in order to achieve a
lucrative exit
http://blog.gust.com/valuations-101-the-risk-factor-summation-method/
Item Description
1 Management Risk
2 Business Stage
3 Legal/Political Risk
4 Manufacturing Risk Very Low Risk +$500k
5 Sales Risk Low Risk +$250k
6 Fund raising Risk Average $0
7 Competition Risk High Risk -$250k
8 Technology Risk Very High Risk -$500k
9 Litigation Risk
10 International Risk
11 Reputation Risk
12 Succesful Exit Risk
RISK FACTOR SUMMATION METHOD
Valuation of each Item
• This method has also an important
degree of subjectivity but could be
useful to start negotiations between
the founder and the investors

37
Valuation Methods
SCORECARD VALUATION METHOD
• This method is one of the most common methods in the valuation of companies in a
PRE-SALES stage
• The method consists in adjusting the initial pre-money valuation (calculated as an average
of similar companies in the industry) according to predefined criteria
• The different weights of those criteria are set up giving more importance, in a Pre-Sales
Stage, to the founders team and the size of the market, and less to the competitive
environment, marketing and funding needs
http://billpayne.com/wp-content/uploads/2011/01/Scorecard-Valuation-Methodology-Jan111.pdf
Item Description Max Weight Value Factor
1 Founders Team 30% 125% 0,375
2 Market Size 25% 180% 0,450
3 Product / Technology 15% 100% 0,150
4 Competitive Environment 10% 75% 0,075
5 Marketing, Sales channels and associations 10% 80% 0,080
6 Extra financing needs 10% 100% 0,100
7 Other 0% 0,000
Total 100% 1,230
Initial Value 1.500.000
Target Value 1.845.000
SCORECARD VALUATION METHOD Example

38
Valuation Methods
VENTURE CAPITAL METHOD
• This method is used considering the point of view of a Venture Capital investor.
• Most venture capitalists are emotionally unattached to a deal. Their primary and core
issue is simple: "What is the exit strategy and potential internal rate of return (IRR) to
the proposed investment"
• In this method the investor estimates the value that the company will have in the future
(exit value). The exit value can be calculated through different methods: market multiples
(x times Sales, x times EBITDA, market share values, etc.) or projected cash flows
(although sometimes difficult and speculative)
• Once you have the Exit Value it is relatively easy to calculate the Post-Money value of the
company
• There are two main methods:
• Return on Investment (ROI) Multiple (x times the investment)
o Post Money Value = Exit Value / Multiple
• Internal Rate of Return (IRR)
o Post Money Value = PV (Exit Value) = Exit Value / (1+IRR)n
http://www.vcmethod.com/

39
Valuation Methods
VENTURE CAPITAL METHOD (ii)
Example:
• A company expects earnings of $1.000.000 on year 4, when the sale of the company is expected
• The company is negotiating with a VC a capital increase of $1.000.000 to develop growth
• The VC has analyzed market comparables and thinks that they can obtain a valuation of 10 times
the earnings at the exit, so the expected Exit Value is 10 x $1.000.000 = $ 10.000.000
• The required IRR (Internal Rate of Return) of the VC, given the characteristics of the company and
the industry is 20% annually and they also expect to multiply by 3x theirs investment in 4 years
• According to IRR
o Post Money Value = Exit Value / (1+IRR)n = $10.000.000 / (1+20%)4 = $4.018.766
o Pre Money Value = Post Money Value – Investment = $4.018.766 - $1.000.000 = $3.018.766
• According to ROI Multiple
o Post Money Value = Exit Value / Multiple = $10.000.000 / 3 = $3.333.333
o Pre Money Value = Post Money Value – Investment = $3.333.333 - $1.000.000 = $2.333.333
• So, according to this method, the Pre-Money Valuation for this company would be
between $2,3m-$3m

40
Valuation Methods
DISCOUNTED CASH FLOWS (DCF)
• This is the most comprehensive and widely used methodology as it requires the
preparation of financial projections (sales, growth, margins, earnings, investments, new
projects, etc.)
• The value of a company is defined as the present value of the projected free cash flows
(FCF) , capitalized at a Discount Rate (K) that takes into account (among other variables)
the level of risk attached to the industry
• This method also has a degree of subjectivity (projection hypothesis, determination of
risk) is preferred for companies in the growth and expansion stages rather than seed or
early stages where the uncertainty of the projections is definitely higher
FCFYear 1
(1+k)1
Value =
FCFYear 2
(1+k)2
FCFYear n
(1+k)n
+ +……+ Terminal Value+

41
Valuation Methods
DISCOUNTED CASH FLOWS (ii)
Example
HIGHGROWTHLOWGROWTH
LOW RISK HIGH RISK
Company A Year 1 Year 2 Year 3 Year 4
Free Cash Flow 100 125 150 180
Terminal Value 1.800
Total 100 125 150 1.980
Discount Factor 1,25 1,56 1,95 2,44
DCF 80 80 77 811
Value 1.048
K 25%
Company B Year 1 Year 2 Year 3 Year 4
Total 100 125 150 1.980
DCF 93 107 119 1.455
Value 1.774
K 8%
Company D Year 1 Year 2 Year 3 Year 4
Total 100 105 110 1.320
DCF 80 67 56 541
Value 744
K 25%
Company C Year 1 Year 2 Year 3 Year 4
Total 100 105 110 1.320
DCF 93 90 87 970
Value 1.240
K 8%

42
Risk & Discount Rate (K)*
time
R
I
S
K
0
SEED
STAGE
EARLY
STAGE
GROWTH
STAGE
EXPANSION
STAGE
EXIT V
A
L
U
E
0
100%
70%
50%
35%
25%
20%
15%
10% 8%
12%
* Discount Rates showed are just for illustrative purposes

43
Valuation Methods
FIRST CHICAGO METHOD
• This methodology assumes that the development of a Start-Up is highly uncertain and
takes into account different scenarios where projections are prepared.
• Scenarios are typically: high, medium, low
• Each scenario is evaluated according to the DCF methodology and weighted according to
different probabilities of occurrence
• Example
• This method is also preferred for companies in the growth and expansion stages
Scenario DCF Value Weight Value
High 1.750 15% 263
Medium 1.200 60% 720
Low 400 25% 100
Total 100% 1.083

44
Valuation Methods
COMPARABLE TRANSACTIONS
• This method compares prices paid in real transactions where the companies are
comparable to the target company we have to evaluate
• There needs to be a reasonable basis for comparison: similar industries, similar size,
similar markets, etc
• There are different valuation ratios that can be calculated, usually:
• Value divided by Sales Value/Sales
• Value divided by EBITDA Value/EBITDA
• Average ratios of comparable transaction are then applied to the target aggregates
(Sales, EBITDA, etc) to obtain an estimation of value of the company
Transaction Year Value/Sales Value//EBITDA
Transaction A 2016 1,2 7,8
Transaction B 2017 1,5 8,5
Transaction C 2017 n.a. 9,3
Average 1,35 8,5
Target Sales EBITDA
Financials 2.500 450
Multiple 1,35 8,53
Value 3.375 3.840

46
Recap
• Valuation is about estimating Cash Flows, Growth and Risk
• When dealing with Start-Up companies, the information
available and the stage of development of the business will
determine which valuation approach is more adequate
• In seed and early stages Start-Ups, the analysis of the team,
product and market is more important than the financials
• Evaluation of risks is key, as the probability of failure is higher
than the chances of success (less than 10% of Start-Ups celebrate
their 10th anniversary)
• Sometimes simplicity and common sense is a better allied that
complicated valuation models

48
Articles and Sources of Information
http://people.stern.nyu.edu/adamodar/pdfiles/papers/younggrowth.pdf
http://www.conector.com/fases-de-inversion-de-una-startups-guia-definitiva/
http://increnta.com/es/blog/fases-financiacion-de-las-startups/
https://www.elblogsalmon.com/conceptos-de-economia/las-fases-de-una-startup
http://www.eleconomista.es/gestion-franquicias/noticias/7641813/06/16/Como-financiar-una-startup-en-cuatro-fases-desde-los-familiares-al-capital-riesgo.html
http://seedcamp.com/resources/how-does-an-early-stage-investor-value-a-startup/
https://www.sociosinversores.com/Como-valorar-una-startup
http://www.eleconomista.es/emprendedores-innova/noticias/6751405/05/15/Cuanto-vale-una-startup-Claves-para-evaluar-un-negocio.html
https://startupsventurecapital.com/valuation-for-startups-9-methods-explained-53771c86590e
https://blog.adioma.com/how-startup-valuation-works-infographic/
https://www.forbes.com/sites/natalierobehmed/2013/12/16/what-is-a-startup/#6d3974324044
https://alejandropalacioscastro.wordpress.com/2014/12/14/la-valoracion-pre-money-y-post-money/
http://cink-emprende.es/formacion-blog/3-metodos-mas-3-libros-para-valorar-tu-startup/
http://www.valoraccion.com/valoracion-de-empresas-como-valorar-una-startup/
http://www.timov.la/article/inversiones-sobre-series-y-rondas-en-startups

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