5 C's of Valuation

Transcription

1 Pre-money Valuation Suresh Madan Portfolio Manager, Excalibur Capital Management

2 Presentation Outline Why Value? How to Value? Valuing Start ups Strategies to Increase Value Discussion

3 My Background Investment Fund Manager Business Valuation Consultant Entrepreneurship/Angel Education: Engineer, MBA, CFA, CIM

4 Financing Underground Mines

5 Financing Canadian Farms

6 Why Value? Financing Strategic Transaction Generation change Basis for Valuation Valuation Financial Fundamentals Firm, Equity or Asset value? Presentation-Audience-Timing do matter

7 Sources of Finance Informal Personal funds Family and friends Employees and Directors Government Grants/ Loans Equity Angels Venture Capital Strategic Partners Customers/Suppliers Public Markets Debt Bank Line of Credit or Overdraft BDC Loans Factoring Leasing Bank Debt for Venture Backed The five Cs of credit 1. Character 2. Capacity 3. Collateral 4. Conditions 5. Capital

8 Approaches to Valuation 1. DCF valuation present value of expected future cash flows Assumptions: Cash flow, life, growth rate, discount rate 2. Comparables P/E, P/B, P/S, P/FCF, etc 3. Metrics Based on industry parameters 4. Option valuation 5. Cost Based Approach 6. VC Method

9 1. Discounted Cash Flow Valuation Intrinsic value: Methodology Based upon return and risk over time Less exposed to market moods and perceptions Work best when cash flows are positive, long horizon, and known risks Estimate the cash flows (earnings, EBITDA, FCF) Estimate initial and recurring Capex and WC Adjust accounting numbers (new owner, tax issues) Estimate cost of capital, annual growth, terminal growth But, assumptions may be noisy

10 2. Comparables Compare with market prices of others Need comparable assets And a standardized measure (sales, earnings or book) Works when intrinsic value impossible to estimate Value is whatever the market is willing to pay Easiest to use when Good comparables and their prices available Preferred by investors with short time horizons Use pricing advantageously during better market moods Requires less information/ assumptions

11 Market Comparables examples Company P/E P/B P/S EV/EBITDA Infosys Wipro IBM igate Cognizant Accenture

12 3. Metrics based valuation Sector Metric Median Value IT Services Revenue/employee $64k Internet Services Number of Users ~$100 Oil/Gas Production Barrels Oil Equi/day $79k Agricultural Farm Land holding $1,129/acre Silver Mining Ozs of Ag Equivalent $2.58/oz Gold Mining Ozs of Gold in Situ $116/oz

13 Feature of Options Some Examples 4. Option Valuation Derive value from an underlying asset May be call or put, with contingent pay-off Quantitative models for valuation available Patents and other barriers to entry (option on technology) Equity in a distressed firm (option to liquidate) Natural resource firm (option on underlying resource) Value of patents Nortel ~$6.5b Motorola M ~$9.5b Kodak ~$0.5b Blackberry ~$2.5b i4i ~$0.3b 254 patents sold for $110k/

14 5. Cost Approach Historical acquisition plus implied return Modified by Valuing individual assets Replacement Value Goodwill valuation Sweat equity

15 6. VC Method* Venture investing is high risk Half of the ventures fail One of ten is a home run Other ventures just breakeven VC Funds must target high return *Developed by Bill Sahlman of Harvard Business School VC investors in the fund for min 5 and max 11 years Investors expect 20-24% annual net return VC must earn 25-30% return before fees VC must target ventures that will generate 20x Post-money value = Sale Price / Expected Return Sale Price > Discounted Cash Flow Method Pre-money Value = Post-Money Value Investment

16 Issues in Valuing Start Ups Superfast revenue growth Consider product life cycle Historical growth in the industry Adjust for any abnormal year Low Initial Margins Normalize earnings Historical growth and margins in the industry Estimate sustainable margins and reinvestment needs No History >> Use comparables No Comparables >> Use history

17 Value Creation Strategies Barrier to Entry Patents, copyrights First Mover Advantage Branding Competitive Advantage Sanctioned monopolies Distribution/off-take agreements Exploration agreements Exclusivity Barrier to Exit Sticky products Switching Costs and Cancellation Policies Top US Brands 1 Apple $153b 2 Google $111b 3 IBM $100b 4 McDonald s $81b 5 Microsoft $78b 6 Coca-Cola $73b 7 at&t $69b 8 Marlboro $67b 9 GE $50b 10 Verizon $42b Source: Millward Brown Optimor

18 Value Enhancement Strategies Increase cash flows or efficiency Increasing market share Launching new products Entering new markets: geographic, demographic Reduce reinvestment needs (WC + Capex) Achieve higher growth Reinvest to higher growth in new products/markets Reduce cost of capital Reduce operating risk/volatility and tax burden Change financial mix Merge with other businesses

19 Investor s Due Diligence Business Model and Scale» Market & Product Potential» Competitive Advantage» Current operations» Near term catalyst Management team Financial Position Valuation» Liabilities including contingent Capital structure» covenants, insider holding, minority rights Any Red flags

20 Investor s are looking for.. Depth of the management team Not a one-man company Sustainability plan and commitment to grow to the next stage Good systems and records Significant market opportunity Differentiated products Strong market share Customer validation Absence of last minute surprises undisclosed lawsuits, loss of major customer, loss of key personnel or advisors, financial misstatement

21 Typical Transaction Schedule EVENT Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Sign Service Agreement Write Opportunity Report Write Profile Profile Approved Mail Profiles Opportunity Report Approved Send Books First Visits Second Visits Third Visits Letter of Intent Due Reserved Acquirers Contacted Negotiate Letter of Intent Sign Letter of Intent Due Diligence Legal Documentation Closing But timing determines value.

22 Negotiations could drag for a while And, while there s no reason yet to panic, I think it only prudent that we make preparations to panic.

23 Fundamentals still apply Let s be clear on one thing: If you take a business that is a bad business and put it online, it s still a bad business, it s just become an online bad business. - Michael Dell Source: Baron's 6/99.

24 Thank You! Questions?