VALUATION EXERCISE- BUILDING A CAP TABLE
Building a full cap table from a limited amount of information can seem daunting.But the process of building a cap table is very similar to solving a SuDoku puzzle.You have a grid of data points (numbers) to fill in, and you are given a few numbers to start with.From the information you have, think about what data point(s) you can fill in next.Continue, filling in one box at a time until all boxes are full. Using the logic from the preceding paragraph, develop a cap table on the following assumptions – A Series B investor will invest $5 million on a $20 million post-money valuation. Existing founders & management have 15 million shares; Series A Investors have 10 million shares.What will the full cap table look like after the Series B investment?
In developing your cap table, use the following process: 1) Create a worksheet with the column headings shown below and list all of the “players” down the left side, 2) enter all known information, 3) calculate ownership % for new investors, 4) allocate pre-money value to existing investors, 5) calculate the price per share (if the price is not the same for all shareholders, something is amiss), 6) calculate the number of shares for the new investor, 7) add the total shares for all investors, 8) calculate the ownership % for existing investors. Be sure to show all your work to the extent possible to enable you to not be penalized for errors that may carry through the model.
Players# of Shares% OwnershipPrice Per Share$ Value NOTE: IF YOU FOLLOW THE STEP BY STEP PROCESS ABOVE, THIS IS A SIMPLE EXERCISE. MOST STUDENTS WHO DO NOT GET FULL MARKS FOR THIS ASSIGNMENT DO NOT FOLLOW THE SEVEN (7) STEPS LISTED ABOVE. DON’T MAKE THAT MISTAKE.
1
Valuation Basics
The Ambiguity of Valuation
Valuation is not solely quantitative
Entrepreneurs must learn valuation methods
but be comfortable with ambiguity
Valuation is an illusion, set more by
market factors than by formulas
Whats the price of your company?
What someone is willing to pay for it?
2
A Willing Buyer and Willing Seller
Apple Computer and Be, Inc.
Apple (Amelio) approached Be to acquire it
Be had revenues of $3 million and 40
employees (financed with $20 million of
venture money)
Apple – $100 MM; Bes counter – $250 MM.
Never came to terms; Apple acquire NeXt
5 years later, Be acquired for $11 MM
Subjective Factors in Valuation
Stage of business
Management team
Industry (or market)
Reason for acquisition or sale
Other factors
Ultimately, cash flows drive valuation
3
Pre-money and Post-money Values
Pre-money is the value placed on the company
prior to the investment
Post-money is the value after the investment
Computed as pre-money + amount invested
Post-money determines how much the investor owns
(or the entrepreneur has given up) as a result of the
investment
Post-money is often pre-money of the next round
Why Value Your Company?
To determine its selling price
To determine how much to give up for
partnering
To determine how much to give up for an
investment
4
How Much Equity
Should You Give Up?
Many entrepreneurs unknowingly establish their
companys value
I want to raise $100,000.
I want to maintain ownership of 90%
Implied post-money valuation is $1,000,000
Entrepreneur retains 90%
A $100,000 investor gets 10%
$100,000 $1,000,000 = 10%
Sophisticated investors may not agree on
equity split or valuation
Summary
Valuations of companies, particularly early
stage companies, is highly subjective
Its a negotiation process
Understanding of terms is essential
Other factors have big impact on
ultimate valuation 1
Key Factors Influencing Valuation
Valuation Process
Valuation is not solely quantitative
Qualitative factors also come into play
A contextual factor analysis, which describes in
what context a valuation is taking place, is needed to
properly value a company
Contextual factors include cash flow (current and
historical), whos involved, availability of capital, and
the team
Many other factors
2
Contextual Factors
Cash flow historical, present, future
Current cash flow is most important
Future cash flow is unknown and primarily the
result of efforts of the new owner
Amount of debt the cash flow can service
Whos doing the valuation?
If VC, wants to keep value low
If entrepreneur, wants to push number up
Contextual Factors
Public or private?
Public companies are valued higher due to
liquidity in the market and better information
Private companies lack liquidity and provide
limited information
Availability of capital.
The greater capital available, the higher the
valuations
Supply vs. demand greater capital chasing, fixed
number of opportunities will compete
3
Contextual Factors
Is it a strategic or financial buyer?
Generally, strategic buyers value companies
higher than financial buyers
Availability of capital for private equity funds
may swing the pendulum
Speculation
Value based on projected future performance can
drive valuations up
Hype vs. Hope
Contextual Factors
Company stage
Early stage = lower valuation
Less risk with later-stage companies
Best advice, develop product and market traction as
long as possible before seeking outside capital
Auction
Buyers bidding on company drives valuation
MSFT outbid Google/Yahoo for 1.6% of
Facebook @ $240 million
Valuation $15 billion! 300 X revenue multiple!
4
Contextual Factors
Economic conditions
Valuations increased 5 consecutive years to 2000
Coincided with sustained U.S. economic growth
Reason for selling
Personal or business pressures?
Settle estate, owner death, etc.
Tangible/intangible assets
Mfg. companies tangible assets
Technology companies intangibles
Contextual Factors
Industry
Similar companies in different industries can have
significantly differing valuations
Internet/e-commerce vs. the field
Quality of management team
Startup experience valued in early stage
companies
If existing team is viewed as weak, valuation can
be lower
5
Summary
Valuations of companies, particularly early
stage valuations, are highly subjective
Valuations are both quantitative and
qualitative
Contextual factors play a large role 1
Valuation Methods
Valuation Methodology
There are numerous ways to value a
company quantitatively and no one method
is superior to all others
Valuation is part science and part gut
3 categories:
Asset-based: rarely used now as mfg. shifts out of
the U.S.
Cash flow capitalization, and
Multiples, widely used for entrepreneurial cos.
2
Multiples
Cash flow multiples
EBITDA X (3 to 10)
Adjusted up and down for contextual factors.
May adjust EBITDA for founder salaries.
Free cash flow multiples.
EBITDA CAPEX
Yields more conservative valuation
Used when company requires major CAPEX to
sustain growth
Multiples
Sales multiples
Widely used, varies by industry
Food industry = 1 to 2 X revenues
Professional services = 1 to 3 X revenues
Software companies = 2 to 3 X revenues
P/E ratio method
For publicly traded companies
Private companies can be based on comps
3
Free Cash Flow
Most complicated and involved
AKA Discounted Cash Flow model
Relies on many projections and assumptions
Simply stated, projected future cash flows
(generally 5 years), adjusted for taxes,
depreciation, working capital and CAPEX,
are discounted to PV using the weighted
average cost of capital of the company
PLUS residual value
Free Cash Flow Formula
Year 1 FCF/(1+DR)+Year 2 FCF/(1+DR)^2 +Year 3
FCF/(1+DR)^3 . . . + RV
Many criticize model due to its complexity and
uncertainties
Bill Sutter (venture capitalist and Stanford Business
School grad) says I have not used any models since
business school valuation is remarkably
unscientific
4
Valuing Technology/Internet Companies
Valuation methods discussed thus far are
not applicable for valuing tech companies
Early companies like Netscape, Yahoo, and
Amazon.com all went public with little to
no revenues at very high valuations
Current models now focus on users and
ultimate revenues attached thereto
Ultimately, financial fundamentals count
Summary
Many valuation methods, none of which is
particularly better than others
Valuation, particularly for early stage
companies, is highly subjective
Valuation is educated speculation
Internet/tech companies dont fit traditional
models
