VENTURE CAPITAL

NOEL J. MAQUILING, MBA CAR, MICB, CFMP, MOS

Venture Capital Methods of Valuation
  A process of determining the current worth or the
VALUATION present value (PV) of an asset mainly for investment
DEFINES analysis, capital budgeting, and other operational
transactions.
 All valuations are based on a careful consideration of
both hard facts and soft factors. It applies a thorough
risk assessment of factors which include:
 Management
 Market

VALUATION RISK  Science and technology

ASSESSMENT  Financials / funding phase
FACTORS
Note: All methods are specifically suited for the
evaluation of technology companies, with high growth
potential and start-up companies of all types. Although
not every kind of valuation method is appropriate,
Venture Valuation assesses each company according to
their industry and financing phase.
  The complete valuation process takes
around 3 to 5 weeks, including an
onsite workshop with Venture
Valuation (VV) experts.
 Prior to the workshop we will review
the company’s business plan,
company documentation, and market
reports and collect preliminary
information to establish a first
impression of the company’s strategy.
 Conduct of an on-site workshop,
usually with two specialists from
VALUATION Venture Valuation and the appropriate
members of the company’s
PROCESS management team. The meeting
normally begins with a short
presentation by the company's
management and a discussion of the
crucial factors related to the
valuation.
 During the meeting VV experts give
support, related to strategic decisions,
using the value-based management
approach. Depending on the
company, as well as the available
documents, this meeting will last half
a day to two days.
  The information we generally require
for a valuation includes (but is not
limited to):
 The business plan
 The budget ( 3 to 5 year forecast)
 The CVs of the management
 The development timelines
 The IP situation
 Prior to the meeting the portfolio
company will be provided with a
VALUATION complete list of information that would
PROCESS 
preferably be required.
The Valuation Report is then written
based on all accumulated information.
External data such as market,
customer, and partner and supplier
information is also considered.
 Note: The writing of a Valuation
Report is an interactive procedure
between VV experts and the
management team; therefore,
continuous contact and information
exchange is maintained.
A GOOD VENTURE RETURN
 Batting Average – The percent times you get on base or
in VC parlance, it is the number of times you make a
successful investment divided by the total number of
investments you make.
 Successful Investment – One that you get at least your
money back.
 Total Write Off – No return of capital or a complete failure
of portfolio companies.
 Example: In a typical portfolio of ten companies, seed/start-up
investors can expect three to five of those companies to fail
completely: no return of capital; a total write-off. Another three or
four will provide some return of capital or a small return on
investment. Investors hope that these three or four companies will
return all the invested capital of the original portfolio at exit.

 Home Runs – An ROI that justifies the considerable risk

involved in seed/start up investing, where the winners must
be home runs yielding 10-50X invested capital.
BASIC FORMULA OF VALUATION

Pre-Money Valuation 1,300,000 65% Before the funding round

Investment + 700,000 35% Funding round

Post-Money Valuation 2,000,000 100% After the funding round

METHODS OF VALUATION
 Exit Year Revenue Estimation
 Use of Multiple Annual Revenues
 Scorecard Method of Valuation
 Dave Berkus (1990) Method of Valuation
 Bill Sahlam (1987) Method of Valuation or Basic
Venture Capital Method of Valuation
 Venture Capital Method with Sensitivity Analysis
 Venture Capital Method with Multiple Financing
Rounds
 Venture Capital Method with Dilution
 Example:
 We estimate our target company can achieve revenues
of 50 Million in the exit year; Well-managed

1
companies in this business segment typically earn 15
percent after-tax earnings; and the market value for
companies in this business is typically 12x earnings (a
P/E ratio of 12).
EXIT YEAR REVENUE  Step 1: Estimate Revenues in the exit year
ESTIMATION  Step 2: Use Industry standards for earnings as a
percentage of revenues.
 Step 3: Find price/earnings ratios for companies in
the business vertical

We can then calculate the terminal value in the nth year at 90

million.
= Estimated Revenue X Industry standards for earnings X P/E Ratio
= 50 million x 15% x 12 = 90 Million.
 Example:
 Companies similar to the target company in the

2 previous example might be selling for twice revenues

in the nth year.

USE OF MULTIPLE
The terminal value by this method, would be:
ANNUAL REVENUES
= 2 x 50 Million = 100 Million
  Step 1: Gather valuations for other pre-revenue
companies in your sector within your geographic
region.
 Step 2: Calculate the average of those valuations.

3  Step 3: Compare your company to similar deals in

your area using the following factors:
 Strength of the Management Team
SCORECARD METHOD  Size of Opportunity
OF VALUATION  Product / Technology
 Competitive Environment
 Marketing / Sales Channels / Partnerships
 Need for Additional Investment
 Other

 Step 4: Compute your venture score.

 Step 5: Compute for your Pre-Money Valuation.
See excel computation at ELABORATE section for further explanation
  Berkus uses both qualitative and quantitative factors
to calculate a valuation based on the following five

4 drivers:

 Sound Idea (Basic value, product risk)

DAVE BERKUS  Prototype (Reduces technology Risk)
VALUATION METHOD
 Quality Management Team (Reduces execution risk)
(1990)
 Strategic Relationships (Reduces market risk and
competitive risk)
 Product Rollout r Sales (Reduces financial or
production risk)

See excel computation at ELABORATE section for further explanation

 A venture capitalist is contemplating a 3.7 million

5
investment in a company that expects to require no
further capital through year seven. The company is
expected to earn 4.5 million in year five and should be
BILL SAHLAM (1987) comparable to companies commanding price/earnings
ratios (PERs) of about 12. The venture capitalist expects
OR BASIC METHOD to harvest his investment at that point through sale of his
OF VALUATION stock to an acquiring company. Assume further that the
venture capitalist requires a 40% projected internal rate
of return (IRR) on a project of this risk. Assume there
are 1 million shares outstanding before the investment.
What is the share price (p) using these assumptions?

See excel computation at ELABORATE section for further explanation

 How will the value of the company change if the
assumptions are changed? The effect of changing the

6
following assumptions in the base model can be
examined:
 Variation 1: Increase the terminal value by 10
percent
SENSITIVITY
 Variation 2: Decrease time to exit by 10 percent
ANALYSIS
 Variation 3: Increase IRR by 10 percent
 Variation 4: Increase investment by 20 percent
 Variation 5: Increase the number of existing shares to
3,000,000

See excel computation at ELABORATE section for further explanation

 A first-round venture capitalist is contemplating a 3 million
investment in a company that expects to require an additional 2
million in a second round. The assumed exit value is 25 million.

7
The venture capitalist expects to harvest his investment at that
point through sale of his stock to an acquiring
company. Suppose that the discount rate is highest in the early
years and becomes lower after a while. For example, assume
that the discount rate is 60 percent in the first year, stays at 50
MULTIPLE percent in years two and three, and falls to 40 percent in the
FINANCING ROUNDS fourth year. In addition to determining the appropriate
compound interest rate for the current round, the first-round
VC must also determine the compound interest rate most likely
to be applied in the second round. Suppose, for example, that
the company might be able to delay the timing of the second
round until year four. Assume there are 1 million shares
outstanding before the investment. What would be the wealth
of the entrepreneurs at the time of exit?

See excel computation at ELABORATE section for further explanation

 A first-round venture capitalist is contemplating a 1.5 million
investment in a company that expects to require an additional 1
million in years two and four. The company is expected to earn
2.5 million in year five and should be comparable to companies

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commanding price/earnings ratios (PERs) of about 15. The
venture capitalist expects to harvest his investment at that
point through sale of his stock to an acquiring
company. Assume further that the first-round venture capitalist
VENTURE CAPITAL requires a 50% projected internal rate of return (IRR) on a
METHOD WITH project of this risk. Since several rounds are required, in
addition to estimating the appropriate discount rate for the
DILUTION current round, the first-round VC must also estimate the
discount rates that are most likely to be applied in the following
rounds, which we will project for years two and four. Although
a 50% rate is appropriate for year zero, it is estimated that
investors in this company will demand a 40% return in year two
and a 25% return in year four. Assume there are 1 million
shares outstanding before the investment. What is the terminal
share price?
See excel computation at ELABORATE section for further explanation
Simple iteration Approach
 This approach assumes that no more
shares in the company will be issued
after this round of funding, so the
percentage of ownership of the
investors will remain constant from
investment to harvest.