The Science and Art of Startup Valuations - Anjana Vivek

The Science and Art of Startup Valuations
TiE Masterclass
BHive Workspaces, HSR Bengaluru
23rd August 2016
Anjana Vivek
anjana@venturebean.com

VentureBean Consulting Private Limited
Valuation: Questions ’to trigger thinking’
Valuation: Methods
Valuation: Process
Valuation: Focus Startup
Valuation: Summary
Agenda
2 2

VentureBean Consulting Private Limited 3
To trigger thinking…
ARE you
Building a Business
or
Building Valuation

• Can your company be the one that grows.. In
business AND Valuation .. in the longer term
• What do you think of when you hear the word
valuation for a business?
• What do you think it is related to?

Is valuation related to..
• Sales
• Cost
• Profit
• Cash flow
• Combination of above
• Other factors? What else?

• For Funding
– Angel funding
– Series A..X/Y
– Strategic
• Funding cum
– Incubation
– Acceleration
• Other
– Mentoring fee
– ESOP plan
• Just because..
Why Valuation?

As a FOUNDER
Put yourself in other party’s shoes…
i.e. what is value to Buyer?
• Valued because of expected return on
investment over some period of time; i.e. valued
because of the future expectation
• Return may be in cash or in kind, tangible or
intangible, or a combination of these
• Identify the drivers of valuation to Buyer

Valuation: Methods
Valuation: Process
Valuation: Summary
Agenda
8 8

Valuation methods
These can be broadly classified into:
• Cost based
• Income based
• Market based
For more details on the methods with examples
please check the Appendix; spreadsheet
illustrations will be shared on request

Some different ways to value
• Cost vs. Market Value
• Historical vs. Replacement
• Differs depending on need of person doing
valuation – investor, entrepreneur, employee,
advisor
• Depending on stage of business, whether for
growth, super growth, exit, distress sale in times
of downturn, closure

Valuation: Methods
Valuation: Process
Valuation: Summary
Agenda
11 11

Valuation
Based on
• Tangibles and Intangibles
• Data and Assumptions
• Subjectivity and Objectivity
12

Valuation
• At idea and early stage there is limited data,
more subjectivity; higher weightage given to
– Team
– Potential market
– Competitive scenario
• At next phase, more weightage is given to
– Customer traction
– Pipeline
– Past record of conversion from pipeline etc.
– Immediate past performance
– Business and financial model
13

Valuation
• Many methods of computation are there, including
but not limited to
– Multiples of revenue, EBIDTA, user base, etc
– Multiples of industry specific value drivers, e.g. GMV
(Gross Merchandise Value), revenue per user, net margin
per user
– Cash flow based, discounted
– Exit valuation expected
• These are again modified sometimes, for example
revenue multiple may be an average of previous
year, current year expected and forecast for year
ahead; or it could be revenue multiple for one year
ahead. The multiples will vary in both cases
14

Valuation
• Financial forecasts
• Are the starting point
• Assumptions may be set out clearly
• Look at different scenarios, optimistic, expected, pessimistic
• Look at sensitivity to key parameters
• Look at funded/bootstrap scenario and partial funding scenario
• In focus in the due diligence review, prior to investment
• Will factor in negotiations, so proceed with care when showing
this to an investor
• Statutory, accounting, tax implications to be
factored in while arriving at valuation and deal
cash flows
15

Valuation
Driven by:
• Markets: Flavor of season, competitive
scenario, industry trends
• Team: At helm plus advisors/mentors/board
• Cash burn: Or cash needed, look at scenarios
of minimum bootstrap and best case
• Percentage sharing: Equity promoter is willing
to let go
16

Valuation
Driven by:
• Unbundling of deal issues, such as
– Board Membership
– Decision making powers
– Payment/salary to founders
– Assistance in administrative matters (eg. Incubation)
– Contribution to execution and participation in key
activities such as sales, partner tie-ups
– Liquidation preference
– Exit clauses
• Negotiation and taking control of the situation
17

Valuation
• Deals can sometimes be structured to
accommodate valuation perceptions
– For eg. linking to future performance
– This could become an area of concern when there is
a possibility of a “down round” when new investors
come into the picture
• For more on valuation: detailed class notes at
http://www.slideshare.net/anjanavivek/valuation-
basics (from set of the Top 4% & 5% viewed on
SlideShare in earlier years)
18

Process of valuation
• Identify current market models relevant to
venture
• Justify methods selected, assumptions made
A valuation range is preferable
to a single number

Process of valuation
• Discount for risks, assign premiums
• Look at expected value
• Arrive at valuation range
– especially the point of walking away from the deal
• Identify deal issues (breaker/maker) for
negotiation
• Practice before negotiating
A valuation range is preferable
to a single number

Valuation: Methods
Valuation: Process
Valuation: Summary
Agenda
21 21

Valuation : Startup
At very early stage valuation is often a function of:
• Amount of cash burn (with different scenarios of
bootstrap and adequate funding)
• Stake promoter is willing to give up
PLUS factors such as
• Value add expected from potential investor
• Expected funds to be raised in future rounds, and
connecting this to future dilution expected to be made
It would help if you can
articulate And
list this

Valuation: Startup to Exit.. To Think Thru

Valuation: Startup Examples – Incubation
Incubation by Tech company for idea stage venture:
• Rs.50 lakhs was committed for 1st year, to be drawn on need
basis
• Admin/accounting support to be provided
• Co-working space provided
• Mentors of centre available and assigned to venture for
periodic meetings
• Domain experts from the pool of advisors to be connected to
founders
• Monthly sustenance fee of Rs.20,000 per month agreed to for
each of 2 founders
• 48% equity with Tech Company and balance held equally by
two founders
• Forecast and valuation was connected to this and articulated

Incubation along with Acceleration for idea development:
• 3 member founding team was selected in a Batch for
acceleration
• Mentors assigned from pool
• 4 month program included sessions on idea development and
business planning for group as well as one-on-one special
sessions with each group of promoters
• At end of period, the business idea and plan would be
evaluated by a panel
• If approved, the founders would be incubated for a further
period of 18-24 months, depending on requirement
• Initial seed funds of Rs.25 lakhs allotted, subject to review
• Equity to be taken, varying between 8-15%, depending on
– Stage of readiness of business
– Team experience
– Requirement and other non-financial ask from incubator
– Forecast and valuation calculated and articulated

Incubation for early stage company:
• Facilities and co-working space provided
• Administration assistance provided
• Mentors, CAs, lawyers and other professionals connected to
• Initial seed funds of upto Rs.25 lakhs available
– Fund requirement to be evaluated
– Funding in tranches, based on milestone
– Utilisation to be reviewed
• Equity between 8-12%, depending on
– Stage of company
– Expected growth plan and projections
– Dilution expected in future rounds of fund raising
– Forecast and valuation calculated and articulated

Valuation: Startup Examples
Names/data changed to maintain confidentiality..
Service business: Value add measures:
• Two year co.
– Rebranded,
– Reclassified domain, pre-funding;
– This was done on advise that revenue multiple would
go up from 3 to 5
• Three year co.
– Changed business model, increased outsourcing of
some service delivery aspects.
– Cost of inputs increased, gross margins reduced
– However operational efficiency increased, net profit
margins increased
– valuation multiples; i.e. revenue and PBT multiples
increased by new potential investors

Valuation: Startup Examples
Investor negotiation:
Early stage idea:
• Jim had high technical knowledge, limited financial
knowledge.
• Investor Z convinced Jim that he could partner and
grow the company to high value in 3 years and
negotiated for half the business.
• Jim got into this without understanding how shares
could get further diluted in later rounds of funding.
• At the end, Jim was left with less than 10% of the
company he started, however valuation was high.

Valuation: Startup Examples – Mentoring
Names/data changed to maintain confidentiality
Edtech Co. 1 year old:
• One face-to-face (FTF) meeting a month (half day i.e 3-4
hours)
• Advisory for growth strategy and mentoring of leadership team
• 2% equity
• by way of investment brought into the company at a small
premium
• Forecast and valuation connected to this and articulated

Health tech idea stage:
• Two meetings a month (2 hour),
• Assistance in business model development
• Funding strategy, in alternate scenarios of bootstrap and
funded, with assistance in fund raising
• 5% equity
• Equity investment brought in at par at the time of incorporation
of company
• Forecast and valuation connected to this and articulated

• Range of equity sharing can vary
– from less than 1% to even 10%, depending on the
experience, value add and brand value add by the mentor
– Sometimes can also include a cash component, for eg
 success fee as a % of funds raised
 % of revenue based on sales lead
• Forecast and valuation should be connected to this
and articulated
• Statutory and tax issues MUST be addressed
while equity is given

Valuation: Quality Factors.... To Think Thru
• FOCUS on Quality not just on Quantity …
• Illustrative parameter: Revenue Quality
– Sales Quantity
– Quality of revenue - in terms of
product/service/vertical/location etc.
– Customer segments addressed
– Average revenue per employee
– Number of customers, number of high value customers
– New customers added
– Customers lost
– Pipeline customers
• Customer acquisition strategy
32

To trigger thinking …
Investment in media/entertainment company: In the days
when valuations were going through the roof…
(numbers changed to maintain confidentiality)
• HewS closed $10 million valuation from InvestorA
• Reading press reports, Investor 2 wanted to participate and asked
the promoters to suggest a valuation
• HewS Team and InvestorA decided at random: 20% increase in 1
week, leading to valuation of $12 million;
• On flight as InvestorA travelled to meet Investor2, he decided he
would not just be a messenger, he would value add, so he decided
to up valuation to $18 m
• During negotiations, Investor2 gave final offer of $15 m
• Thus in about 10 days the company valuation went up by 50%, from
$10 m to $15 m
• Founders ended up with more money than they had planned for and
had to think of ways to spend this!
TODAY the story is reversed.. Valuations are dropping/fluctuating

To trigger thinking …
Ref: Economic Times: Feb 29, 2016:
Flipkart’s valuation markdown: Billions gone in a flash
ReadMore@:http://economictimes.indiatimes.com/articleshow/51182907.cms?from=mdr
&utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

Valuation: Methods
Valuation: Process
Valuation: Summary
Agenda
35 35

Valuation
• Identify valuation methods and drivers in your
industry
– Number of customers?
– Revenue?
– GMV?
– Number of unique views?
– Average revenue per customer?
– Profitability?
– Cash Flow generated?
– Combination of above?
– Other?
36

Valuation
• Identify what could be
– Value drivers
– Value depleters
37

Valuation
• At the start value is mostly intangible, look at
how this can be made tangible..
• For eg. service – through content, follow up
calls, showcasing feedback, etc.
• Can you think of how you can demo value in
early days of your business
38

Valuation
Some examples of value demonstrated:
• Association with credible organisations (incubation, acceleration etc..)
• Team: Reputed/trustworthy; experienced/multi-disciplinary
• Marquee/discerning customers
• Other stakeholders associated – Advisors, investors, bankers, well
known professional service firms etc.
• Feedback/testimonials from reputed persons
• Ability to charge premium pricing
• Ability to address a huge market – i.e. ecommerce companies, value
without profits
For more: 5 Points on Valuation and Negotiations… OR … how You can get
a better price
39

In Summary
• Build a Financial Model that is consistent, capture
elements of business model; address deal
rationale
• Look at different valuation models; arrive at a
value range
• Prepare for negotiation
– Identify deal issues
– Think through possible negotiation strategies
– Check that your house is in order for due diligence, else
you may provide hooks for pulling down your valuation
40

In Summary
Caution
• Look out for concern issues, hidden agendas; evaluate on
value-based parameters including but not limited to fund
source, governance, ethics and reputation
• Keep an eye on the law and statutory regulations; these
also impact valuation and deal negotiation
• Plan for advisors/CAs/lawyers, due diligence costs and
other deal related costs which will add to the price paid or
reduce the price received for any transaction
• Plan for long term impact of decisions on valuation
41

Thank you
42
Reference:
For teaching notes, articles and more on finance, valuation, business models,
leadership and more..
• www.slideshare.net/anjanavivek (Global TOP 4%/5% for 2 years)
• https://www.linkedin.com/today/author/anjanavivek?trk=prof-
sm
• https://www.linkedin.com/pulse/venture-a-question-start-up-
valuation-anjana-vivek?trk=mp-reader-card
• https://twitter.com/VentureBean
• http://www.linkedin.com/company/venturebean-consulting-
private-limited
• https://www.facebook.com/pages/VentureBean-Consulting-
Private-Limited/387846908091034

More on Valuation Methods
APPENDIX

Valuation methods
Broadly classified into:
• Cost based
• Income based
• Market based
• Different experts have different classifications
of the various methods of valuation
• Within these methods, there are sub-methods
• Sometimes the methods overlap

Cost based methods
There are different ways of arriving at cost:
• Book value
• Replacement value
• Liquidation value
NOTE: These methods could become relevant
– In times of valuation downrounds; to get salvageable value
– when one is considering the accounting, legal and tax
impacts of valuation, for eg.
• in deals related to M&As, JVs and partnerships etc..
• in cross-border transactions, depending on countries involved

Income Based methods
• Earnings capitalisation method or profit
earning capacity value method
• Discounted cash flow method (DCF)

INCOME: Earnings capitalisation method
• Also known as Profit earnings capacity value
(PECV)
• Value determined by capitalising earnings at a
rate considered suitable
• Assumed that the underlying value driver of the
company is its future earnings potential
• Suitable for fairly established business having
predictable revenue and cost models
• For example
– assume that Company Profittee Limited is earning post
tax profit of Rs. 5 crores and we would like to capitalize
this at 10%.
– The value of the Profittee Limited under this method is
equal to Rs. (5/10%) crores, ie Rs. 50 crores.



 

nt
t
t
t
r
CF
Value
1 )1(
• CF = cash flow
• t = the year and
• r = discount rate
i.e. the cash flow for each year from year 1 to year n (which is the time
period under consideration) is discounted to arrive at the present value
of future cash flows from year 1 to n
INCOME: Discounted cash flow

• Based on expected cash flow & discount rates
• Quality of valuation is dependent on the
assumptions behind the forecast
• Sometimes it is difficult to get a reliable
estimate for the future and the valuation model
may need modification, for example as below:
INCOME: Discounted cash flow
Value: Phase 1
Discounted
Value: Phase 2
Terminal Value
Figure: Net present value
NPV of
Enterprise
Discounted
Discounted

Market based method
• Also known as relative method
• Assumption is that other firms in industry are
comparable to firm being valued
• Standard parameters used like multiples of
revenue, EBIDTA, PAT, book value,
• Other indicative parameters such as revenue,
revenue per user, net margin per user etc.
• Adjustments made for variances from
standard firms or deals in the recent past,
these can be negative or positive; i.e.
premiums and discounts are assigned

Exercise in Valuation - I
Plantation Co. Garden Co. Park Co.
Enterprise value/sales 1.4 1.1 1.1
Enterprise value/EBITDA 17.0 15.0 19.0
Enterprise value/free cash flows 20 26 26
Meadows Co.
Sales Rs. 200 crores
EBIDTA Rs. 14 crores
Free cash flow Rs. 10 crores
How would you value Meadows Co. based on
the market/industry information provided?

Plantation Co. Garden Co. Park Co. Average
Enterprise value/sales 1.4 1.1 1.1 1.2
Enterprise value/EBITDA 17.0 15.0 19.0 17.0
Enterprise value/free cash flows 20.0 26.0 26.0 24.0
Application to Meadows Co. Average Value
Sales Rs. 200 crores 1.2 Rs. 240 crores
EBIDTA Rs. 14 crores 17.0 Rs. 238 crores
Free cash flow Rs. 10 crores 24.0 Rs. 240 crores
Exercise in Valuation – I: Possible Solution

Papers Co Docs Co. Prints Co.
Enterprise value/sales 2.6 1.9 0.9
Enterprise value/EBITDA 10.0 21.0 4.0
Enterprise value/free cash flows 21.0 30.0 24.0
Application to PenPencil Co.
Sales Rs. 300 crores
EBIDTA Rs. 15 crores
Free cash flow Rs. 7.5 crores
Exercise in Valuation - II
How would you value PenPencil Co. based on
the market/industry information provided?

Papers Co Docs Co. Prints Co. Average
Enterprise value/sales 2.6 1.9 0.9 1.8
Enterprise value/EBITDA 10.0 21.0 4.0 11.7
Enterprise value/free cash flows 21.0 30.0 24.0 25.0
Application to PenPencilCo. Average Value
Sales Rs. 300 crores 1.8 Rs. 540 crores
EBIDTA Rs. 15 crores 11.7 Rs. 175.5 crores
Free cash flow Rs. 7.5 crores 25.0 Rs. 187.5 crores
As there is a wide value range, the application of the
relative multiples does not look appropriate in this
case. What are your thoughts on this?
Exercise in Valuation – II: Possible
Solution

• Simple and easy to use
• Useful when data of comparable firms and assets are
available
• Useful when information about recent deals are
available
Limitations
• Difficulty in getting data, particularly for unlisted
companies
• Easy to misuse
• Selection of comparable can be subjective
• Errors in comparable firms get factored into valuation
model
Market based method

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