1. finance
2. investing
3. venture capital

August 28, 2014
Presented By
Stephen Thau, Partner
©2014 Morrison & Foerster LLP | All Rights Reserved | mofo.com
Company Valuations:
A Guide for Entrepreneurs
Valuation Truths
• Valuations are:
 More art than science
 What the market says your company is worth
 What a disinterested investor is willing to pay
• Not: Family member, existing equity holder, corporate investor
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Valuation Terminology
• Valuation: value of equity interests
 Fully diluted: include all shares that could be issued,
but not all authorized
• Pre-money: value of equity before financing
 fully diluted shares x price per share
• Post-money: value of equity after financing
 fully diluted shares x price per share
• Post-money– Pre-money = amount raised
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Valuation Terminology
• Valuation of all equity interests
• Not accounting valuation
• Not 409A valuation
• Not control premium
• Not minority investment
• Not enterprise value
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Startup Valuation Truths
• Investment decisions are driven only by
projected returns on the investor’s investment
• Negotiation, with no correct answer
• Other terms matter too (option pool,
preferences, voting rights, etc.)
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Valuation Not Only Determinant of Founder Value
• Option Pool
Investors
Investors
Founders
Founders
Option Pool
Option Pool
$1M @ $3M Pre
25% Option Pool (post)
Founder Value = $2M
$1M @ $3M Pre
5% Option Pool (post)
Founder Value = $2.8M
• Liquidation Preference



Non-Participating
Participating
Participating with cap
• Dividend Rights (cumulative vs. non-cumulative)
• Antidilution Protection
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How Much Do You Need to Raise?
• How much money you need to show significant
growth or achieve next value-enhancing
milestone
• How much of the company do you SELL (not
give) to the investor
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Rule of Thumb: Raise to Value Enhancing Milestone +
• Early stage investors are looking for rapid growth
• e.g., 10X growth in 18 months
• Valuation is responsive to milestone achievement
•
•
•
•
Prototype completion
Product launch
First 1M users
etc.
• Things always take longer and cost more than
anticipated
• Budget past milestones for runway to raise next
round
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Investor’s Perspective
• Where and when is the exit?
• How much can this company sell for?
• How much total money will it take to grow the
company to the point that someone will buy it
for…..let’s say, $1 billion?
• What percentage will the investor need to get the
return (ROI) desired? 10x? 20x? 50x?
• Desired IRR? (Internal Rate of Return) >25%
(per annum)
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Market Considerations
• Entrepreneur Valuation Expectations*
 Too Low 9%
 Appropriate 22%
 Too high 69%
• All markets are affected by national trends
• Follow-on investors are not always local
• Entrepreneurs have limited experience of
valuation
*According to Angel Resources Institute
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Angel Group Valuation Survey
• National Survey of Angel Group Investment
Activity – Q1 2014
 Pre-money valuations: $2.7 million
 Mean Round Size: $1.23 million
 Median Round Size: $980K
 Mean Round Size (w/co-investors): $2.43 million
 Median Round Size (w/co-investors): $1.65 million
Source: Halo Report – SVB, Angel Resource Institute, CB Insights
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Angel Group Valuation Survey
• By Verticals
 Median for Healthcare deals: $1.21 million
 Median for Internet deals: $1.85 million
 Median for Mobile/Telecom deals: $1.0 million
 Healthcare, Internet & Mobile/Telecom comprised 71.4% of deals
Source: Halo Report – SVB, Angel Resource Institute, CB Insights
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Typical Expected Rates of Return
STAGE
Seed/Start-up
Early Stage
Growth
Later Stage
IRR
82%+
60%
40%
25%
5 Year ROI
20x
10x
5x
3x
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Useful Estimation Methods
• Comparable Transactions
• Comparable Companies
• Venture Capital Method
• Double Revenues Method
• Scorecard Method
• Risk Factors Method
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Comparable Transactions
• Theory: compare valuation to similarly situated
companies raising capital at similar stages
• Reality
 Real data hard to come by
 Anecdotes hard to defend
 Investors can easily find distinguishing features
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Comparable Companies
• Theory: compare valuations of similar
companies when they were at similar stage of
development
• Reality:
 More data may be available (recently public companies report 3-5
years of historical results)
 Perceived selection bias (not everyone will be next Google)
 Prepare to defend assumptions re growth
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Venture Capital Method
Terminal Value
Return on Investment
(ROI)
(valuation at Exit)
=
__________________
Post-Money Valuation
(Valuation at Investment or
Pre-money plus investment)
Assuming no dilution
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Terminal Value
Terminal Value = Revenue x Earnings x P/E Ratio
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Estimating Terminal Value
Investment
Exit year
Revenues
Earnings (Net Profit)
P/E
Terminal Value
$.5 million
5th year
$20 million
10% ($2million)
15 x
$30 million
Reminder: Terminal Value = Revenue x Earnings x P/E Ratio
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Venture Capital Method Made Easy
• Determine the potential value of company at exit
(“terminal value”): i.e., $150MM
• Determine the return on investment required:
i.e., 20X
• Calculate Post-Money: $150MM/20 = $7.5MM
• Determine size of investment: i.e., $3MM
• Calculate Pre-Money: $7.5MM- $3MM= $4.5MM
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Venture Capital Method – Working Backwards From Exit
• Estimate terminal value
• Project all financing rounds to exit
• Build in valuation step-ups for each round
• Work backward to determine initial pre-money
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Venture Capital Method – Working Backwards From Exit
5x Step-Up to
Exit
3x Step-Up from
Post-A to Pre-B
Assume: $100M exit and $10M
capital raise, with $2M
Series A and $8M
Series B
$8M Series B – 5x Return to Exit
 Post-Money = $20M
 Pre-Money = $12M
$2M Series A – 3x Step-Up from
A→B
 Post-Money = $4M
 Pre-Money = $2M
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Scorecard Method
• Determine median value for pre-revenue
companies in your space in your region (recent
deals)
• Assign % weighting on each critical issue
• Calculate the weighted average of each issue
• Multiply median value by weighted average
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Valuation Factors
• Management
• Size of Opportunity
• Products /Services
• Marketing/Sales
• Competition
30%
25%
15%
10%
10%
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Calculate Weighted Average Multiple
FACTOR
Management
Opportunity
Product
Sales
Competition
Other
ANALYSIS
WEIGHT RESULT INPUT
On board except sales
30%
120% 36%
Large
25% 130% 33%
Disruptive
15%
130% 20%
No channels
10%
50%
5%
No big layers
10%
110% 11%
Need partners
10%
80%
8%
Weighted Average
112%
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Calculate Pre-Money Valuation
Median Value
Weighted Multiple
$2.0 million
1.12
Pre-Money Valuation
$2.3 million
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Risk Factor Method
• Determine a starting valuation point
• Consider and assess risk
• Assign positive or negative values to each
• Pre-money valuation = Sum
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Risk Types
•
•
•
•
•
•
•
•
•
•
•
•
Management
Stage of Business
Legislative/Political Risk
Manufacturing Risk
Sales & Marketing Risk
Funding/Raising Capital Risk
Competition
Technology Risks
Litigation Risks
International Risk
Reputational Risk
Potential Lucrative Exit
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Assign Values to Each Risk
• Maximum/Minimum = +3/-3
• i.e., “Stage of Business Risk”
 0 for pre-revenue
 +1 for beta
 +3 for paying customers
• +1= $100k added to pre-money valuation
• -3 = $-300k subtracted from pre-money
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Example
Management
Stage of Business
Legislative/Political Risk
Manufacturing Risk
Sales & Marketing Risk
Funding/Raising Capital Risk
Competition
Technology Risks
Litigation Risks
International Risk
Reputational Risk
Potential Lucrative Exit
+2
+1
0
-1
-3
-1
+1
+2
0
+1
0
+1
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Risk Factor Summary Example
Base Valuation
$2,000,000
Total value of plusses (8)
+ $800,000
Total value of minuses (5)
- $500,000
Pre-Money Valuation
$2,300,000
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Concluding Truths
• Returns drive investment decision
• Calculations generally did not included dilution
events such as the impact of subsequent
investments
• Valuation is an art not a science
• More important to calculate it rationally and not
emotionally
• Use multiple methods
• Estimated valuations are fine to get the
conversation started
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Contact Information
PARTNER
PALO ALTO/WASHINGTON D.C.
(202) 887-1571
[email protected]
Stephen Thau has been representing emerging companies for close to twenty years. His
practice focuses on the representation of technology, life science and medical device
companies in transactional matters, including public and private financings, mergers and
acquisitions, licensing and collaborations and strategic alliances. He also represents venture
capital and investment banking firms in public and private financing transactions. He has
represented companies in numerous public offerings, public and private M&A transactions,
and collaboration agreements, and companies and investors in over 100 venture capital and
debt financing transactions.
Mr. Thau is a frequent speaker on venture capital financings and served on the faculty at the
2005 and 2007 Emerging Entrepreneurs workshops at Stanford University. Mr. Thau is
recommended as a leading lawyer by Chambers USA 2014, Legal 500 US 2014 and Best
Lawyers in America 2012. He was also named to the Daily Journal's inaugural list of 25
leading biotech lawyers in California, in 2011.
Rankings
He is ranked in Chambers USA 2014, Legal 500 US 2013-2014 and Best Lawyers in America
2012.
Education
Harvard University (A.B., magna cum laude, 1989)
Stanford University (J.D., Order of the Coif, 1994)
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