# Presentation: 769448

## © 2005-2006 by The University of North Carolina’s
Small Business and Technology Development Center

- Small Business and Technology Development Center

**NIH  SBIR / STTR****  CONFERENCE**
***VALUATION***
**JULY 13, 2006**
**CLEVELAND, OHIO**

## “To wealth, even if it’s only on paper.”

**Notes:**
Important to recognize that a valuation is someone’s opinion of value – not an exact formula result
Affected by preferences, trends, even portfolio balance

## Key Questions

- What are the factors in valuing the company?
- What ***is***  vs  What  ***has been***  vs  What ***might be***
- Overview of methodologies
- Revenue vs pre-revenue
- What about multiples?
- What is my I.P. worth?
- Shouldn’t I be compensated for my sweat equity?

## Some key factors in valuation

- Historical performance
- Length of time, stability of earnings, relative risk, trends
- Book value
- Income / EBITDA
- Future cash flows
- Appeal
- Perceived risk
- Current Market

## Overview of Methodologies

- Book Value – Assets less Liabilities – *limited use*
- Market Value – comps of similar investments
- Income Value – free cash flows, discounted
- Average of relevant methods – weighted as appropriate

**...****for acquisition of ongoing firms...**

## Overview of Methodologies

**Market Value**
- Comparable firms
- Industry, size, industry position, model, public firms
- Common-sized and adjusted
- Multiples: Price-Sales, Price-Earnings, Price-Cash Flows, Price-Assets, etc.
- Real estate appraisal model

## Overview of Methodologies

**Income Value**
- Income projections
- Expected future free cash flows
- Discount factors applied

## But what about early-stage ventures?

**Remember, they have**
- Limited track record
- Highly variable or Negative profits
- Negative cash flows
- Partial management team
- Additional risk of start-up

## What about pre-revenue firms?

**Valuation without a track record...**
-  May apply public multiples with discounts
- 	- Limitations of multiples
-  Factors beyond projections
- Management team experience
- Industry appeal
- Trends & Current Market Reality

## Financial expectations?

**Remember:**
**Investors are participants in a marketplace**
- Expectations will vary
- Choices are many
- Angel investments are part of a portfolio
-                       ...the *High Risk* portion

## The Ultimate Factor in valuation?

- The Market

- VALUATIONS OF VC SEED/STARTUP ROUNDS

**$ millions**

**Source: NVCA**

## What about my I.P. ?

- DO THIS FIRST !
- Evaluating the market potential will determine **IF** the time and cost of obtaining a patent will be  worthwhile

## The truth about patents

- In reality, there are a lot of new ideas out there
- Only about one patent in a hundred is commercially successful !

## Benchmark Rates of Return

_*Stage of Business*_*	*_*ROI*_*	**	*_*5 yr X-factor*_
*Seed**	**	**	**	**60%**	**	**   **	**10x*
*Start-up**	**	**	**50%**	**	**	**  8x*
*Early-stage**	**	**	**40%**	**	**	**  5x*
*2**nd** Stage**	**	**	**30%**	**	**	**  4x*
*Near exit**	**	**	**25%**	**	**	**  3x*

**      ****Risk-adjusted for stage of development:**

## ROI and X FactorsHow are they related?

_** **__**ROI**__**	**__**Year 1**__**	**__**  Year 2**__**	**__**   Year 3         Year 4        Year  5**__**	**__** Factor**_
-   **10%****	****110%****	****   121%****	****    133%****	****       146%              161%****                  *****1.6 X*****	**
** **
**  ****25%****	****125%****	****   156%****	****    195%****	****       244%              305%****                  *****3.1 X***
** **
**  ****50%****	****150%****	****   225%****	****    338%****	****       506%              759%****	****     *****7.6 X***
** **
**100%****	****200%****	****   400%****	****    800%****	****     1600%            3200%****	****   *****32.0 X***

*	**	**       ****[1 + rate of return]****** ******years to exit***
***Multiplier (X-factor) =****** _____________________________***
***	******	******	******	******100***

*	**	**       ****[1 + .5]****** ******5***
***e.g.  50% ROI =****** _____________________________ ******=  7.6 X***
***	******	******        ******100***

## Venture Returns over TimeSource:  Garheng Kong, Intersouth Partners

## The Ultimate Factor in valuation?

- The Market

**From an individual *****investor’s***** perspective ...**

## A Sample Early-Stage Portfolio

**Invstmt    X Factor   5-yr ARR               Invstmt        X Factor   5-yr ARR**
-    1         Zip       0   %
-    2         Zip       0   %
-    3         Zip       0   %

**Notes:**
I’m listening at the cocktail party. 
I can talk at the cocktail party.
I’m the talk of the cocktail party.
I’m throwing the cocktail party.
I’m looking for a cocktail party.  To find more investors!  
This is the Baddest News.  I’m still hanging on to the hope that it’ll turn around.  Or better, that we’ll find a buyer – a ‘Bigger Fool’...

## A Sample Early-Stage Portfolio

**Invstmt    X Factor   5-yr ARR               Invstmt        X Factor   5-yr ARR**
-    1         Zip       0   %                6             1.6      10  %
-    2         Zip       0   %                7             1.6      10  %
-    3         Zip       0   %
-    4         1.3       5   %
-    5         1.3       5   %

**Notes:**
I’m listening at the cocktail party. 
I can talk at the cocktail party.
I’m the talk of the cocktail party.
I’m throwing the cocktail party.
I’m looking for a cocktail party.  To find more investors!  
This is the Baddest News.  I’m still hanging on to the hope that it’ll turn around.  Or better, that we’ll find a buyer – a ‘Bigger Fool’...

## A Sample Early-Stage Portfolio

**Invstmt    X Factor   5-yr ARR               Invstmt        X Factor   5-yr ARR**
-    1         Zip       0   %                6             1.6      10  %
-    2         Zip       0   %                7             1.6      10  %
-    3         Zip       0   %                8             7.6      50  %
-    4         1.3       5   %
-    5         1.3       5   %

**Notes:**
I’m listening at the cocktail party. 
I can talk at the cocktail party.
I’m the talk of the cocktail party.
I’m throwing the cocktail party.
I’m looking for a cocktail party.  To find more investors!  
This is the Baddest News.  I’m still hanging on to the hope that it’ll turn around.  Or better, that we’ll find a buyer – a ‘Bigger Fool’...

## A Sample Early-Stage Portfolio

**Invstmt    X Factor   5-yr ARR               Invstmt        X Factor   5-yr ARR**
-    1         Zip       0   %                6             1.6      10  %
-    2         Zip       0   %                7             1.6      10  %
-    3         Zip       0   %                8             7.6      50  %
-    4         1.3       5   %                9           20.0      82  %
-    5         1.3       5   %

**Notes:**
I’m listening at the cocktail party. 
I can talk at the cocktail party.
I’m the talk of the cocktail party.
I’m throwing the cocktail party.
I’m looking for a cocktail party.  To find more investors!  
This is the Baddest News.  I’m still hanging on to the hope that it’ll turn around.  Or better, that we’ll find a buyer – a ‘Bigger Fool’...

## A Sample Early-Stage Portfolio

**Invstmt    X Factor   5-yr ARR               Invstmt        X Factor   5-yr ARR**
-    1         Zip       0   %                6             1.6      10  %
-    2         Zip       0   %                7             1.6      10  %
-    3         Zip       0   %                8             7.6      50  %
-    4         1.3       5   %                9           20.0      82  %
-    5         1.3       5   %              10	        Life Support

**Portfolio Return on Investments 1-9      ****??****   %**

**Notes:**
I’m listening at the cocktail party. 
I can talk at the cocktail party.
I’m the talk of the cocktail party.
I’m throwing the cocktail party.
I’m looking for a cocktail party.  To find more investors!  
This is the Baddest News.  I’m still hanging on to the hope that it’ll turn around.  Or better, that we’ll find a buyer – a ‘Bigger Fool’...

## A Sample Early-Stage Portfolio

**Invstmt    X Factor   5-yr ARR               Invstmt        X Factor   5-yr ARR**
-    1         Zip       0   %                6             1.6      10  %
-    2         Zip       0   %                7             1.6      10  %
-    3         Zip       0   %                8             7.6      50  %
-    4         1.3       5   %                9           20.0      82  %
-    5         1.3       5   %              10	        Life Support

**Portfolio Return on Investments 1-9  ****3.7 X  ********  26 %**

**Notes:**
I’m listening at the cocktail party. 
I can talk at the cocktail party.
I’m the talk of the cocktail party.
I’m throwing the cocktail party.
I’m looking for a cocktail party.  To find more investors!  
This is the Baddest News.  I’m still hanging on to the hope that it’ll turn around.  Or better, that we’ll find a buyer – a ‘Bigger Fool’...

## Investor’s Perspective

- 	Investors aren’t necessarily greedy ... they require a high rate of return to make up for their portfolio investments that don’t hit it big

## The VC Method of Valuation

**Investment**
**Exit Year**
**Revenues (5th year)**
**Net Profit (5th year)**
**P/E (industry)**
**Company Value**
**Required ROI**
**Required Valuation**
**% of Company Required**
**Pre-money Valuation**
**Post-money valuation**

- $1 million
- 5th Year
- $20 million
- 10% = $2 million
- 12.5X
- $25 million
- 40% = 5X
- $5 million
- 20%
- $4 million
- $5 million

## VC Method in practice

- It helps to understand the numbers
- Potential investors will run the models to verify
- At the end of the day ... investors are
- Looking for _reasonable value_
- If don’t get the _return_, won’t go there
- Not a lot of room for negotiation

## Pre- and post-investment

- Some variables shift with the investment
- Total value of firm
- Relative balance of ownership

- Example demonstrated

## Capitalization Table

## Capitalization Table

**Implications:**
**	**
**	****Dilution**
**	****Each Round**
**	****Downstream**

##           The dreaded “Cram down”

## What’s a Cram Down?

- Current investors = “Cramees”
- upset because overpaid  lose support
- Prospective investors = “Cramors”
- will walk away   the ‘invisible no’
- You
- self-inflicted wound

**Notes:**
the invisible no is just like when investors walk away because your valuation is out of line with the market

## Key points

- Aim for a “fair market” valuation
- Don’t overprice early rounds, or you’ll likely get hurt in the end
- Focus on the dollars (#) vs. the equity stake (%)
- 10% of $20MM is a lot better than 100% of 200K

## Non-financial valuation factors

- Management team
- Size of opportunity
- Product or service
- Sales channels
- Stage of business
- Size of round
- Need for more funding
- Quality of plan

- 0-30%
- 0-25%
- 0-10%
- 0-10%
- 0-10%
- 0 - 5%
- 0 - 5%
- 0 - 5%

**Source: *****The Power of Angel Investing***** – Kauffman Foundation**

## Suggestions for CEOs

- Learn what investors look for and expect
- Know why they are important to the investor
- Understand the factors that influence value
- Consider all importance areas – not just those within your comfort level
- Anticipate investor questions
- Look at competitive deals
- Learn from the process – listen well

## A day in the life of an entrepreneur