1	Valuation of Startups © Copyright 1978-2008, Ben Livson, BAL Consulting P/L™. All rights reserved. It has yet to be proven that intelligence has any survival value. Arthur C. Clarke 2 is not equal to 3, not even for large values of 2. Grabel's Law
2	On True Entrepreneurs A true entrepreneur does not need capital: HP started with $538 in 1938, Microsoft & Apple capital was $5000 in the 1970s DEC-Gen Doriot $70K 1957-> $350m 1971 All you need is a customer Paul Allen on Microsoft – IBM Mail Order – UPS in the USA
3	No Investor – No Value Liquidation value = net assets – full liabilities Most companies have net nil or negative value. Assets are realized at a fraction but liabilities have to be paid out in full. Build your value by: Get investment – prove yourself to investors Build a track record of financial performance Exit by Private Trade Sale or Public Listing The real company value only known at exit
4	Progression of Investors Founders: keep records & ensure legal separation Family, Friends & Fools Doctors & Dentists Angels Lead Venture Capitalist Other VCs à due diligence by referral Government Funding Warning: syndicate to keep no of shareholders<10
5	Stage Definition Seed Startup Early Stage Expansion Management Buy-Out/Mature/Exit
6	Exit Strategy @Silicon Valley 20,000 enterprises 15,000 – 16,000 fail (75%-80% failure rate) 3,000 – 4,000 trade sales (15%-20%) 300 NASDAQ IPOs (<2% make it to IPO) IPO strategies Immediately – founders known in industry After proven financial performance
7	Approaches to Valuation The market approach – comparative – suitable when value yet another dot.com; the income approach - recognizes future earnings by calculating the present value of projected cash flows at a reasonable present value discount rate. and the asset-based approach – results in the lowest valuation based on expenditure.
8	Valuation Jargon Financing Round: Seed, First, Second, Third, Mezzanine and IPO Pre-Money Valuation: post-money valuation of a company at a financing round minus the amount raised at that round. Step-Up in Value: increase in pre-money valuation between two financing rounds e.g. $10m/$2m = x5 Return on Capitalization (ROC): annualized change, or growth, in pre-money market capitalization between two rounds.
9	Valuation Dilemma Economic Profit = Invested Capital x (ROIC – Opportunity Cost of Capital) How do you forecast ROIC when a startup has no revenue, next to nil physical assets, good will as premium on valuation and IP? Partial answer: V&V measurable milestones Minimum ROIC for startups: 40% (30% risk of having to write-off investment altogether)
10	Myths v Reality Granted clusters of patents in key markets may be worth millions 90% of NASDAQ is about true blue chips with 15+ to 100 years of proven financial performance, years of high profitability and massive protected intellectual property: IBM, AT&T, Cisco, Microsoft, HP, Sun .. Ideas are worth millions – ideas are an unpaid prerequisite – VCs invest in implemented ideas NASDAQ is about dot.coms
11	Insight into Patents Cost: Provisional $2K à International Search $20K à National Granted $30K à Global $400K à global cluster of patents $multi-million IP protection is a major business function Patents are a CSF for many Australian success stories: Cochlear, ResMed, Orbital Engine and Metal Storm Utility required but no $value is necessary Watch: IP assignment to company & no sharing 5+ years provisional à intntl search à pending national à granted national à global cluster
12	What’s behind VC’s 20%+ IRR? Vast differences in VC performance: A quarter of VCs loose their funds A quarter of VCs barely maintain funds A quarter of VCs gain commercial bank interest A quarter of VCs have 30%+ IRRs For each ten investments: 3 Dogs , 4 Walking Dead, 2 Cash Cows and 1 Home Run = the reason why you are a VC
13	Bell Mason Diagnostics By Gordon Bell DEC & Heidi Mason Regis McKenna When you can measure what you are speaking about, and express it in numbers, you know something about it: but when you cannot express it in numbers, your knowledge is of a meagre and unsatisfactory kind: it may be the beginning of knowledge, but you have scarcely, in your thoughts, advanced to the stage of science. -William Thompson, Lord Kelvin 1882-1907) Popular Lectures and Addresses, 1891-94
14	The 4 Elements of Bell-Mason The four major elements of the Bell-Mason Diagnostic include: 1. The five stages of company growth 2. The twelve dimensions that are measured to assess a start-up 3. The rules used to evaluate each dimension 4. A relational graph plotted against the ideal model for success
15	The Twelve Dimensions The twelve dimensions are grouped into 4: Technology/Engineering, Manufacturing and Product Business plan, Marketing and Sales CEO, Team and Board of Directors Cash, Finance-ability and Operations/Control
16	Bell-Mason Dimensions - Stages
17	Bell Mason Stages Flowchart
18	Process Approach Offer Need Claims Due Diligence Key Terms Negotiation and Deal
19	Approach Best startups are approached Passive 2^nd Board Advertising: ASX e.m .. IPO.com Conferences as pickups for date Well promoted sophisticated web-sites Universal Law of <= 6 Degrees of Separation Do your homework: no unsolicited approaches More than 90% of proposals rejected on approach and many due to primitive approach Thorough analysis of your investor(s) is critical before you make your 1^st move
20	Offer Presentations – meet the key people NDA+schedule, business plan & financials Quality and timeliness of obtaining an up-to-date Information Memorandum VC’s level of good will is very high at the beginning and decreases exponentially over time. Be prepared. You cannot buy time lost VCs spend >80% waiting for startups to act.
21	Need Be specific about the need for investment Needs are not questioned at the beginning Need determines investment Equity = Investment/Valuation Lead VC equity =>25% and <=50% If $1m need, valuation =>$2m and <=$4m If justified, AusIndustry can match $ for $
22	Claims Self-critique & integrity are priceless and the only way to build a successful business Never refer to a party without naming it VCs detest name droppers Never make claims that cannot be verified Measurable milestones -> payment schedule Be careful about forecasting revenue
23	Due Diligence Referential due diligence strongly preferred 1^st due diligence is costly & takes time Sloppy cooperation is a big warning sign DD is about people: key management and advisory group will get reference checked Books are usually a no-brainer except for the color of money spent Expert opinion: 1 & 2 pass
24	Key Terms Board seats, minority protection e.g. veto Rights on future capital raisings Terms on future finance e.g. anti-dilution Payments driven by verifiable milestones Handling of undeclared liabilities Service contracts Exit mechanism
25	Negotiation & Deal VC’s 1^st offer is always the best offer and probably the last offer as well based on 20+ years of experience as an employee and small business Negotiation must be less 3 weeks – goodwill decreases exponentially over time VCs are for a WIN-WIN and have every incentive to offer you a good deal
26	Warning Signs Everything centers around the CEO Wife & husband .. Bros .. business No hurt money – just personal time 70% of investment spent in 3 months J curve or “hockey stick” revenue forecast Percent of market without milestones No competition, no research, no disclosure
27	Ideal Startup True partnership of 3-4 founders. CEO is only the first among equals Coal face paid >75% of expenses World class advisory group Hurt money – extra mortgages & give up secure jobs. Startup is not a hobby. True achievements e.g. US patent granted