Valuation 101

As we continue touring our virtual university for startups, we take a much closer look at Starting Up the site we touched upon in the last week's Enable. We highly recommend that you check out the entire site and especially the section on valuations which is summarized below.

A Primer On Valuations

One of the toughest questions facing any company that seeks to raise money is - what is the valuation? Helpful methods of valuating startups can be found in the Stock and Equity section of Startup. In an article entitled Thinking About Valuation author Joe Hadzima provides several ways to help you value your startup. His approaches include:

• Discounted Cash Flow - According to Hadzima, the most basic approach to valuations is the discounted cash flow (DCF) method. What are the projected revenue/profit numbers in 5 years when the investor wants to get his money out? What are the price/earnings multiples for comparable companies today? Multiply these numbers to get an assumed value in year 5 and then discount that number back today. The discount rate is a judgment call based on a number of variables including risk and the current market for similar investments. Venture capitalists often talk of a 30 to 40% annual compounded return target. The result of the analysis is what the value of the company is today. Obviously the analysis involves a number of judgment calls but if you do a sensitivity analysis by varying the assumptions you would be surprised to see the number of times when you can't get anywhere near the valuation an entrepreneur is asking.

  Hadzima says the main challenge for high-tech startups is to get the Investors to focus not on past revenues but rather on the DCF of their new products.

• Comparables: Hadzima admits that sometimes, but rarely, the DCF analysis is enough. Another valuation technique that he mentions is to look for a comparable. For example, Hadzima suggests that if an acquisition is a realistic exit strategy then look at what prices have been paid recently for comparable companies. If there have not been comparable company acquisitions in your industry because the technology is too new or whatever, then look to acquisitions which have been made in other industries for reasons which are similar to why you think your company will be an attractive candidate.

Not A Science or An Art

Hadzima goes on to state that valuation is not a science but it is not totally an art either. Do your homework and build a realistic, defensible set of projections. Most importantly, you must "own the numbers" by having a well thought out consistent, believable story about why your plan will succeed- that can really help you get your valuation.

Enable wishes all of its readers a very healthy, happy and prosperous Jewish New Year.

Published by Israel's Business Arena on October 3, 2000.