Anilesh Seth Ideator, Co Founder & CEO, KROW www.krow.in Strategic Advisor to the Qatalys Group of Companies Mentor at the KYRON incubator Visiting Faculty at CMR IT Exec MBA program Ex-CEO/MD: LGSI, Qatalys & Supervalu India www.slideshare.net/anilesh http://In.linkedin.com/in/anileshseth [email protected]
This is the 7th in the 8th session course on Entrepreneurship for working executives and this provides an overview of the different methods of valuing a company with emphasis on the DCF method. A couple of examples of how startups in India have increased their valuation have also been included based upon publicly gleaned information
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Transcript
Anilesh Seth
Ideator, Co Founder & CEO, KROW
www.krow.in
Strategic Advisor to the Qatalys Group of Companies
• A certain amount of money available today is worth more than the same amount available in the future
• This is because the money available today can earn interest – hence money is worth more, the sooner it is received
• If you had to make a choice to collect a Rs 100,000 lottery that you won, today, or two years from now, which would you choose?
Some fundamentals first: Present and Future Value of money
• Let’s say you are going to invest 10,000 today @10% interest per year
• The future value of this investment is FV1= 10,000*(1+10%) = 11,000 • At the end of the second year this will be worth FV2 =
11,000*(1+10%) = 12,100 • Or FV2 = 10,000*(1+10%)*(1+10%) • Or FV2= 10,000*(1+10%)^2 • The general equation is : FVn = PVn*(1+i)^n • Conversely, to find the Present Value we would use the
equation: PVn = FVn/((1+i)^n)
Some fundamentals first: Discounted Cash Flow (DCF)
• DCF is at the core of arriving at company valuation, based upon expected future cash flows
• We would need to obtain the present value of each of the future cash flows
• To do so we need to “discount” each such cash flow to the present
• The discount rate to be applied would ideally be the WACC or the weighted average cost of capital – which is nothing but a blend of the cost of equity and debt
• For a start up this is more an “art” than a science! • An investor who is seeking a 10 times return in 5 years may
want you to pass the 59% discount rate test!
Example of a DCF calculation
All monetary figures in rupees
DISCOUNT RATE 30.00%
Year 1 Year 2 Year 3 Year 4 Year 5
NET CASH FLOW 10,00,000 50,00,000 1,50,00,000 5,00,00,000 10,00,000
Year 1 discounted 7,69,231
Year 2 discounted 29,58,580
Year 3 discounted 68,27,492
Year 4 discounted 1,75,06,390
Year 5 discounted 2,69,329
TOTAL=PV 2,83,31,022
Or use the formula =NPV(rate, VAL1, 2) 2,83,31,022
Remember that the general formula for PV of a future cash flow is PVn=FVn/(1+i)^n
Remember to discount each cash flow to the present and then add them all up
Raising money
• Beauty, like Value is in the eyes of the beholder!
• Yet we still need to arrive at some value for our start up if we want to raise money
• There are many methods of arriving at value – at the end of the day these are ranges that you use to negotiate
• Some methods that are employed are: DCF, Asset Based, Proxy Based (based upon industry averages), Cost-plus based
Example of a start up: projected cash flows of a B2C start up: How much to raise and how much to dilute?
ALL MONETARY FIGURES IN RUPEES
YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5
TOTAL REVENUE - - - 9,55,000 2,61,03,198 15,62,84,806 43,32,45,539 1,20,03,90,883
LESS CAPEX 6,00,000 31,05,000 94,70,000 38,15,000 65,40,000
LESS DEPOSITS 2,16,000 9,09,000 - 34,11,000 -
TOTAL CASH NEEDED -98,96,012 -7,19,38,829 24,81,420 24,81,47,086 96,35,73,047
Analysis
• How much money is required for Year 1? Should we raise more than that amount? If yes, how much more?
• Considerations:
– Present valuation and therefore dilution
– Lead time required to raise money in the future: don’t forget your “burn rate” will be increasing
Some more terms
• What is pre-money valuation? Simply put, this is the value of your firm before you have raised money. Lets say based upon future cash flows your firm valuation is Rs 10 crore. This is pre-money valuation – or the value BEFORE you have infused money from your investors • What is post-money valuation? This is nothing but the pre-money valuation plus the funding amount that you are seeking. So in the above example if you are raising Rs 1 crore then your post=money valuation is Rs 10 crore plus Rs 1 crore = Rs 11 crores
Some more terms
• What is dilution? This is the amount of control you would be giving away in terms of stock, when you raise money. Remember that Pre-Money dilution and Post-Money dilution is not the same • In the previous example, the pre-money value is Rs 10
crore. If you are raising 1 crore, and you agree to a pre-money dilution, then the value of your enteprise AFTER funding is deemed to be Rs 10 crore out of which you are giving away 1 crore worth or 10%.
• However if you agree to give away stock on a post-money valuation basis then the value of your company is Rs 11 crores and you are giving away 1/11 = 9.09%
Some more terms
• Do we assume that after 5 years the company ceases to operate? We can’t do that…
• But we can assume that it will settle down to a lower growth rate that reflects its maturity over time
• Hence in the fifth year we should compute a “terminal value” of the company that is reflective of its future cash flows – albeit at the lower growth rate. This terminal value too needs to be discounted to the present and added to the present value to arrive at the true enterprise value
• The general formula for this is:
Final projected year cash flow * (1 + long term cash flow growth rate)/(Discount rate – long term cash flow growth rate)
OK…back to our example
• Without worrying about the added complexity (tho strictly speaking required) of the terminal value, the Present Value of the cash flows projected over 5 years is: – At a discount rate of 20%: About Rs 45 Crores – At a discount rate of 30%: About Rs 29 Crores – At a discount rate of 40%: About Rs 20 Crores – At a discount rate of 59%: About Rs 10 Crores
• Remember, if we had used the terminal value also, these figures would be higher
• Assuming a valuation of 20 Crores has been agreed with the prospective investor, this is the Pre-money valueation of the company
• If you are raising Rs 1.5 Crores at this stage, your Post-money valuation would be 21.5 Crores and you would be diluting 1.5/21.5 or roughly 7% of your company
Illustration of how value accrues
• Here is a simplified example of how value accrues as the founders dilute more over time to raise cash. This is purely illustrative and simplified to show dilution on the part of the founders only, in each subsequent round…
Stage Timeline Value Funding Post Money Dilution (%) Founders Stake Founders Value
Idea/Formation 1 Yr Ago 10,00,000 0% 100.000% 10,00,000
POC/Angel Now 5,00,00,000 50,00,000 5,50,00,000 9.091% 90.909% 5,00,00,000
Series A 1 Yr Later 22,00,00,000 8,00,00,000 30,00,00,000 26.667% 64.242% 19,27,27,273
Series B 2 Yrs Later 1,50,00,00,000 30,00,00,000 1,80,00,00,000 16.667% 47.576% 85,63,63,636
Founders holding % decreases
Founders holding value increases
TIME
In rupees
OK – now onto a quick treatise on other methods of valuation
• Asset based: Net tangible book value: – All tangible assets (like cash, WDV of assets, accounts receivable, etc) minus all
liabilities and debt
• Revenue multiple: X * Revenue • Earnings multiple: X * EBITDA
– Use the average industry profitability as a proxy/indicator
• Cost plus: Sometimes a start up will arrive at a valuation based upon the market value of the effort they have put in plus a premium on the idea/product that they have created
The problem with valuing a start up is that you have no history to show. Hence investors will talk about the management team, the “traction” gained, entry barriers patentable idea that you may have , recent valuations in similar cases etc…. All the valuation techniques enable you to write down indicative ranges based upon different approaches/industry proxies and provide both you and the investor a starting point To negotiate…. Remember that an idea is as good as its execution – and hence the importance of the management team…
Examples of how value accrues
Company redBus
Launched August 2006
Capital Rs. 5,00,000
Feb 2007 First round
$1 million Seed Fund and undisclosed investors. •$500,000 - Seed Fund. •$500,000 - other investors
July 2009 Second round
$2.5 million - Inventus Capital Partners, Seed Fund and other unnamed investors
May 2011 Third round
$6.5 million - Helion Venture Partners, Inventus Capital and Seedfund
March 2013 •Net revenues -Rs 55 crore •Expected to post a net profit of around Rs 2 crore for FY13.
June 21, 2013 Ibibo Group acquires redBus at an estimated $100 million (about Rs 600 crore).
Company Flipkart
Founded 2007
Capital Rs. 4,00,000: Sachin Bansal and Binny Bansal
2009
1st round
$1 million: Accel India
•Assume 15% stake sale at $6.6m valuation. Promoter +
Employees = 85% | Investors = 15%
2010
2nd round
$10 million : Tiger Global.
•Assume 30% stake sale at $33m valuation. Promoters
+ Employees = 59.5% | Investors = 40.5%
June 2011
3rd round
$20 million: Tiger Global.
•Assume 25% stake sale at $80m valuation. Promoters
+ Employees = 44.625% | Investors = 55.475%
Company Flipkart
August 2012 4th round
$150 million : MIH (part of Naspers Group) and ICONIQ Capital. •Assume stake sale of 15% at $1b valuation. Promoters + Employees = 37.93% | Investors = 62.07%
10 July 2013 5th round
$200 million: Existing investors including Tiger Global, Naspers, Accel Partners and Iconiq Capital. •Assume stake sale of 17% at $1.2b valuation. Promoters + Employees = 31.48% | Investors = 68.52%
Oct 10, 2013 $100million: • Additional 160 million funding announced