Entrepreneurship and Startups

Startup Funding
 Agenda

• Definition
• Importance
• Methods
• Stages
• Valuation
• Success stories
Definition & Importance
 What is a startup?

• Can any small business be described as a startup ?

• Are they only related to tech companies?
• Is it necessary to be an innovative and new idea ?
• Is a five years old company a startup?
• When a startup moves away from startuphood ?
 What is a startup?
• A startup is a young company that is just beginning to develop. Startups
are usually small and initially financed and operated by a handful of
founders. These companies offer a product or service that is not currently
being offered elsewhere in the market, or that the founders believe is being
offered in an inferior manner.(Investopedia)

•  Founders emphasize that a startup is a culture . “Startup is a state of

mind,” says Adora Cheung, cofounder and CEO of Homejoy, one of the 
Hottest U.S. Startups of 2013. “It’s when people join your company and
are still making the decision to forgo stability in exchange for the promise
of tremendous growth and the excitement of making immediate impact.”
 Characteristics of startups

• Growth : One thing we can all agree on is that the key

attribute of a startup is its ability to grow. A startup is a
company designed to scale very quickly
• This growth is unconstrained by geography which
differentiates startups from small businesses. A restaurant in
one town is not a startup, nor is a franchise a startup.
•  If you’ve just set up a tiny for-profit enterprise and are intent
on it becoming big enough to take over the world – even if
you’re still working from your bedroom – you’re probably a
startup founder.
 Characteristics of startups

• Innovation - startups need to be very innovative.

• Structure - at the beginning, they are unstructured and
virtually with no hierarchy and managers.
• Resources - usually extremely limited.
• Team - the environment requires small team, usually includes
some recent graduates with little experience but a lot of skill
and speed.
• Uncertainties - Startups deal with many uncertainties : market
, competition, people and finances.
• High risk - due to innovation and the various uncertainties
involved, the failure rate is high.
 Why are start-ups needed?

● A startup is a way to translate inventions into

commercial goods and services that benefit the public.
● Also serve as an engine for local economic
development and job creation.(Uber)
● A research by the Global Entrepreneurship Monitor
South Africa (2012) states that one third of dynamics
of countries’ economic growth can be attributed to the
dynamics of startup entrepreneurship.
 Funding startups
•In the early stages, startup companies' expenses tend to exceed their
revenues as they work on developing, testing and marketing their idea.
As such, they often require financing.
•According to the 
2016 Small Business Credit Survey: Report on Startup Firms , which
was a collaboration of all 12 Federal Reserve banks , more than two-
thirds of startup firms faced financial challenges in 2016.
•The survey also found that 52 % of all startups had applied for
financing. However, 28 % of startups that applied were not approved for
any financing, while an additional 41 % received some but not all the
financing that they had sought.
 Challenges

• The bigger challenge for most startups is that it is

much harder to get your startup funded than it was
in the past, simply because there are far too many
startups vying for the much-wanted funding.
• Investors are setting higher benchmarks for every
startup because they want to ensure that their
money is parked in a startup that has a promising
future.
 considerations for attracting
funds for Startups
• Startups need to invest time and money into research. Market
research helps determine the demand of a product or service.
• A startup requires a comprehensive business plan outlining mission
statement, future visions and goals as well as management and
marketing strategies.
• Entrepreneurs must calculate their start-up needs so they can
communicate this information to potential funders.
• This requires estimating start-up costs, capital expenditures, working
capital (operating costs), and contingency funds.
 Presenting Information to
Possible Investors
• A concise presentation should include the
following:
• What is the market opportunity?
• Why is it irresistible?
• How will the business make money?
• Why is this the right team at the right time?
• How does an investor exit the investment?
 What to Look for in Investors

• Seek investors who:

■ Are considering new financing proposals and
can provide the required level of capital.
■ Are interested in companies at the particular
stage of growth.
■ Understand and have a preference for
investments in the particular industry.
 What to Look for in Investors

• Seek investors who:

• Can provide good business advice, moral support,
and has contacts in the business and financial
community.
• Are reputable, fair, and ethical and with whom the
entrepreneur gets along.
• Have successful track records of 10 years or more
advising and building smaller companies.
 What to Look Out for in
Investors
• Avoid investors who exhibit these warning signs:
■ Attitude
● Be wary if the investor thinks he or she can run
the business better than the lead entrepreneur or
the management team.
■ Over commitment
● Be wary of lead investors who indicate they
will be active directors but who also sit on the
boards of six to eight other startup and early
stage companies.
 What to Look Out for in
Investors
• Avoid investors who exhibit these warning signs:
■ Inexperience
● Be wary of dealing with venture capitalists who
are under 30 years of age and have:
• No operating, hands-on experience in new
and growing companies
• A predominantly financial focus
 Minimizing Surprises
• Tips to consider when raising capital:
■ Raise money when you do not need it.
■ Learn as much about the process and how to
manage it as you can.
■ Know your relative bargaining position.
■ If all you get is money, you are not getting much.
■ Assume the deal will never close.
■ Always have a backup source of capital.
■ The legal and other experts can blow it—
sweat the details yourself
Methods
 Bootstrapping

• Bootstrap is a situation in which an entrepreneur starts a company

with little from personal finances or from the operating revenue of
the new company.

• Most entrepreneurs get their businesses started by bootstrapping.

• Boot strapping can be beneficial, as the entrepreneur is able to

maintain control over all decisions. On the downside, however, this
form of financing may place unnecessary financial risk on the
entrepreneur.

• Furthermore, boot strapping may not provide enough investment for

the company to become successful at a reasonable rate.
 Bootstrapping

• Bootstrapping  operating a business as simply as possible

and cutting all unnecessary expenses.

• Bootstrapping involves:
• Hiring as few employees as possible
• Leasing anything you can
• Being creative
• Asking suppliers to allow for longer payments terms.
• Asking customers to pay in advance, or sell their
accounts receivable to a factor.
 Friends and Family

• Friends and family investors have their distinct plusses

and minuses.  The plusses are these people know the
entrepreneur the best, so they are the closest to him in
determining whether or not he is backable, as first hand
references. 
 Friends and Family

• The minuses are pretty major:  friends and family!  It is very

difficult to mix personal and professional relationships. 
And, as we know, only one in 10 startups is successful.  So,
there are very high odds the entrepreneur lose all the money
invested by his closest friends and family,  So, if he decide
to ultimately go down this road (which for many startups are
their only option), friends and family know this investment
is HIGHLY risky, and they should not invest the funds
unless they are prepared to lose 100% of their investment
(e.g., like money they would gamble in a casino).
 Incubators

• Definition: An organization designed to accelerate

the growth and success of entrepreneurial
companies through an array of business support
resources and services that could include physical
space, capital, coaching, common services, and
networking connections .
 Incubators

• Business incubation programs are often sponsored

by private companies or public institutions, such as
colleges and universities. Their goal is to help
create and grow young businesses by providing
them with necessary support and financial and
technical services.
 Incubators

• Incubators provide numerous benefits to owners of startup

businesses. Their office and manufacturing space is offered
at below-market rates, and their staff supplies advice and
much-needed expertise in developing business and
marketing plans as well as helping to fund fledgling
businesses. Companies typically spend an average of two
years in a business incubator, during which time they often
share telephone, secretarial office, and production
equipment expenses with other startup companies, in an
effort to reduce everyone's overhead and operational costs.
 Y Combinator
• Y Combinator. taking into account the 172 companies
that have been acquired, shut down or raised funding,
the total value is $7.78 billion, for an average of $45.2
million per company. It’s a remarkable figure,
considering the Mountain View, Calif.-based firm has
been in existence for seven years. The data is of course
skewed by certain large companies.
 Y Combinator

• Y Combinator did not identify individual companies’

valuations in data that they provided, but Dropbox and
Airbnb are very large. Still, even if you remove the two,
the firm still has a strong hit ratio and number of
absolute hits. Some of its biggest exits include: 280
North, Heroku, OMGPOP, Loopt, Cloudkick, Zecter,
Wufoo and Reddit. For comparison, last June, Y
Combinator said its top 21 companies were 
worth $4.7 billion.
 What are startup
Accelerators?
• Startup accelerators support early-stage, growth-driven
companies through education, mentorship, and
financing. Startups enter accelerators for a fixed-period
of time, and as part of a cohort of companies. The
accelerator experience is a process of intense, rapid, and
immersive education aimed at accelerating the life cycle
of young innovative companies, compressing years’
worth of learning-by-doing into just a few months.
 What are startup
Accelerators?
• Accelerators are playing an increasing role in startup
communities throughout the United States and beyond.
Early evidence demonstrates the significant potential of
accelerators to improve startups’ outcomes, and for
these benefits to spill over into the broader startup
community. However, the measurable impact
accelerators have on performance varies widely among
programs — not all accelerators are created equally.
Quality matters.
 AngelPad

• AngelPad is a entrepreneurship accelerator program

based in NYC and San Francisco. Since 2010 .
• launched more than 130 companies. Every 6 months
there is a selection of about 15 teams from a huge pool
of applicants (usually around 2000) to work with
Angelpad.

•  Find awesome companies with founders to work with

and spend three very intense months with them.
•  This focus has paid off, Angelpad have risen to be 
the #1 Accelerator in the U.S. .
 AngelPad

• During the program, we work on everything from

finding product market fit, defining a target market to
getting first validation for the company. We are also
instrumental in helping companies prepare for
fundraising and of course for investor meetings.
 What at AngelPad do

• Mentorship

• Mentorship is at the core of AngelPad,work side-

by-side with founders to come up with the best,
biggest and most disruptive companies.
 What at AngelPad do

• Network
• Working, not just alongside, but with the other
startup founders at AngelPad will become the
foundation of the support system.
• form a close bond with all AngelPad Alumni.
 What at AngelPad do

• Funding
• AngelPad provide funding for each company that
enters AngelPad. Not a lot, but enough to get through
the first year.
 What at AngelPad do

• Investors
• Getting funded is a key component of startups success and
a core focus at AngelPad. To build a meaningful, eventually
very large and profitable company, Access to capital
needed.
•
Most global investors invest in and what gets them excited.
Investors know the quality of companies coming out of
AngelPad. Being an AngelPad company opens many doors.
 Angel investors

• Angel investors (not venture capital firms) are the most

likely candidates to get the businesses from a piece of
paper to a proof-of-concept.  These angel investors
typically come in four distinct groups:
• Friends and Family
• Individual Angel Investors
• Angel Investor Networks
• Via Fund Raising Advisers
 Individual Angel Investors
• As for finding angel investors directly, this is the hardest route, by
far.  First, because they prefer to stay anonymous.  And, second,
because they don't know you at all.  Sometimes rich individuals
have built formal family investment offices, with professional
managers screening deals for them.  But,if they can afford a family
office, they prefer to invest $5M+ in more typical venture
investments, not $500K for a startup.  Preferably, startup need to
find an individual that understands their business model and can
bring real value to the table.  If they have first hand experience in
space, and they think they can help accelerate business, it is easier
for them to get over the investment hurdle.  So, identify those
individuals, and try to figure out someone they know, who can
credibly make an introduction for startup.
 Angel Investor Networks
• This category, is a favorite category: networks aggregating angel
investors.  Like the family offices, investors set aside funds for angel
investments, screened by a professional team that sources deals for
the network.  So, the individual angel gets to keep their comfort of a
team of smart managers doing due diligence on investment targets,
on their behalf.  So, instead of one angel investing $1M by
themselves, 100 angels aggregate $100M and invest as a group in
the deals they like the best, individually or collectively. 
 Via Fund Raising Advisers
• If all of the above fails, entrepreneur should consider engaging a
boutique startup fund raising adviser.  The problem with this road is
raising funds via this channel can be more expensive, with the
advisor typically taking a 5%-7% success fee in cash, plus the same
dollar amount in warrants to buy into the deal, and often times, plus
a monthly retainer to cover their costs.  So, if entrepreneur is not
confident in his own abilities to raise capital, perhaps an outside
adviser can help.  But, like investors themselves, advisers typically
take on clients they think will be easiest to sell to investors.  So,
making sure that the story will resonate with them too is vital.
 Jeff Bezos

•  CoFoundersLab, one of the largest networks for entrepreneurs,

compiled this list by evaluating the number of startups each angel
investor funded to date according to publicly available data, in
addition to their influence in the early-stage startup ecosystem.
Sources used during research process 
• With less than 3% of seed deals being funded by venture capitalists,
seed startup fundraising has become more accessible thanks to the
rise in angel investor activity in the past few years. Between friends
& family financing, which is estimated to be a $100 billion industry
 and angel activity estimated at $20 billion,  more than $120 billion
dollars are invested in early-stage startups annually.
 Jeff Bezos

• Jeff Bezos is the Founder, President, Chief Executive Officer, and

Chairman of the Board of Amazon.com. Under his leadership,
Amazon.com became the largest retailer on the Web and the most
widely adopted model for Internet sales.
• In 1999, Time Magazine named him Person of the Year. In 2011, 
The Economist gave Bezos and Gregg Zehr an Innovation Award
for the Amazon Kindle, and in 2012, Fortune magazine named
Bezos Businessperson of the Year. Businessweek ranked him the
no. 7 Top Angel in Tech in February 2010, and the Harvard
Business Review also has listed Bezos as the second-best CEO in
the world, after the late Steve Jobs of Apple.
 Debt financing

• Debt financing is available in some form for most small business

owners. It is most popular with traditional business, such as those
companies in the  manufacturing or retail sectors. With traditional
debt financing, borrowers retain complete control of their business,
and they have a finite agreement with their lender.
 Debt financing
• However, the repayment and interest terms can be steep.
Borrowers typically begin making payments the first month after
the loan has funded, which can be challenging, because the
business isn't on firm financial footing yet.
• Another disadvantage of debt financing is the potential for
personal financial losses if it becomes impossible to repay the
loan. Whether a business owner is risking their personal credit
score, personal property, or previous investments in their
business, it can be devastating to default on a loan.
 Debt financing
• Debt financing includes both secured and unsecured loans.
Security involves a form of collateral as an assurance the loan
will be repaid. If the debtor defaults on the loan, that collateral is
forfeited to satisfy payment of the debt. Most lenders will ask for
some sort of security on a loan. Few, if any, will lend you money
based on your name or idea alone.
 Debt financing
• There are some types of security you can offer a lender:
• Guarantors sign an agreement stating they'll guarantee the
payment of the loan.
• Endorsers are the same as guarantors except for being required,
in some cases, to post some sort of collateral.
• Co-makers are in effect principals, who are responsible for
payment of the loan.
• Accounts receivable allow the bank to advance 65 to 80 percent
of the receivables' value just as soon as the goods are shipped.
• Equipment provides 60 to 65 percent of its value as collateral for
a loan.
 Debt financing
•Securities allow publicly held companies to offer stocks and bonds as collateral for repaying a
loan.
•Real estate, either commercial or private, can be counted on for up to 90 percent of its assessed
value.
•Savings accounts or certificate of deposit can also be used to secure a loan.
•Chattel mortgage applies when equipment is used as collateral--the lender makes a loan based
on something less than the equipment's present value and holds a mortgage on it until the loan's
repaid.
•Insurance policies can be considered collateral for up to 95 percent of the policy's cash value.
•Warehouse inventory typically secures up to only 50 percent of the loan.
•Display merchandise such as furniture, cars and home electronic equipment can be used to
secure loans through a method known as "floor planning."
•Lease payments can be assigned to the lender, if the lender you're approaching for a loan holds
the mortgage on property you're trying to lease.
 Debt financing
• In addition to secured or unsecured loans, most debt will be
subject to a repayment period. There are three types of
repayment terms:
• Short-term loans are typically paid back within six to 18 months.
• Intermediate-term loans are paid back within three years.
• Long-term loans are paid back from the cash flow of the
business in five years or less.
• The most common source of debt financing for startups often
isn't a commercial lending institution
 Venture Capital (VC)
● A type of private equity typically provided to early-
stage, high-potential, growth companies in the interest
of generating a return
– Initial Public Offering (IPO)
– Sale of the company
● Venture capital fund is a pooled investment vehicle that
primarily invests the capital of third party investors in
enterprises that are too risky for standard capital
markets or bank loans
 How Venture Capitalists
Works?
● Venture partner typically receive 2% of the funds’ committed capital
as a management fee + an additional 20% of the funds’ net profits
● The structure of the VC fund determines the type of inventions they
are interested in
● Software and technology ~5 years
● Life sciences ~7-10 years
● VCs asses investments in terms of risk
● A better understanding of a potential company’s risk profile creates a
stronger pitch for investors
● Inexperienced management teams and unrealistic claims can turn off would
be investors
● VC funds are not ATMS
VCs fund success rate
 When to contact VCs?

• The earlier a firm accepts VC money, the more control

these investors can exert (earlier investments are riskier,
so VCs can demand more favorable terms).
• VCs usually have deep entrepreneurial experience and a
wealth of contacts and can often offer important
guidance and advice, but strong investor groups can
oust a firm’s founder and other executives if they’re
dissatisfied with the firm’s performance.
VCs type by investment
 Crowdfunding
• Reward-based crowdfunding , where sites like Kickstarter and
Indiegogo are global leaders. Users can back the projects they like
and get something material in return (physical or digital products
and services), receiving no equity from the teams or companies
providing such goods.
• Equity crowdfunding, backers (investors) of the companies get
equity in return most popular sites are Seedrs, Fundable,
Microventures and Eureeca (small amounts of capital from a
large number of individuals )
Massolution's Global Crowdfunding Report expects
crowdfunding to becomea $300 billion industry by 2019/2020
Crowdfunding process
Eureeca
Eureeca
 IPO

• An initial public offering (IPO) is the first time that

the stock of a private company is offered to the
public. IPOs are often issued by smaller, younger
companies seeking capital to expand, but they can
also be done by large privately owned companies
looking to become publicly traded.
 IPO
• Advantages of IPOs
• Large Amounts of Funding
• Going Back For More
• Higher Profile
• Shares of the company become a kind of currency
• Disadvantages of IPOs
• Expensive and Complicated
• Diluted Ownership
• Giving Out Information
• Answering to Shareholders
 Investment bankers

• Investment banking is a specific division of banking related

to the creation of capital for other companies, governments
and other entities. Investment banks underwrite new debt
and equity securities for all types of corporations, aid in the
sale of securities, and help to facilitate mergers and
acquisitions, reorganizations and broker trades for both
institutions and private investors
• Gets 5 – 7% brokerage fees
Investment banking top players
Stages
 Funding Rounds
• Seed round where company insiders provide start-up capital (bootstrapping – FF)
• Angel round where early outside investors buy common stock (Angel Investors)
• Series A, Series B, Series C, etc. Generally, the progression and price of stock at
these rounds is an indication that a company is progressing as expected (VCs)
• Series AA, BB, etc. Once used to denote a new start after a crunchdown
or downround, i.e. the company failed to meet its growth objectives and is
essentially starting again under the umbrella of a new group of funders.
Increasingly, however, Series AA Preferred Stock investment rounds are
becoming used more widely along with convertible note financings (VCs)
• Mezzanine finance rounds, bridge loans, and other debt instruments used to
support a company between venture rounds or before its initial public offering
(debit)
Startup Stages
 Runway and Burn Rate
Runway: The amount of time (#months) until your startup goes out of
business, assuming your current income and expenses stay constant.
Typically calculated by dividing the current cash position by the current
monthly burn rate.

Burn Rate: Average of cash spent monthly before generating

positive cash flow from operations (self-sustaining) or need future
financing; it is a measure of negative cash flow.

Example:
If a company has $1 million in the bank, and it spends $100,000 a month,
its burn rate would be $100,000 and its runway would be 10 months,
derived as: ($1,000,000) / ($100,000) = 10.
 Investment Convertible Notes

• Short-term debt that converts into equity, typically

in conjunction with a future financing round
• Discount Rate : valuation discount received relative
to investors in the subsequent financing round
• Valuation Cap: caps the price at which notes will
be converted into equity with
Valuation
 Business Valuation
1. What is Business Valuation ?

2. Valuation Approaches

3. Business Valuation Methods

4. Other valuation aspects

 What is Business Valuation ?
• The process of examining various economic factors of a business using predetermined
formulas to assess the value of the business or an owner's interest in a company.

• Or it is a process and a set of procedures used to estimate the economic value of an

owner's interest in a business.

• Business valuation may be conducted to provide an accurate snapshot of the

company's financial standing to present to current or potential investors. The Internal
Revenue Service requires that a business be valued based on fair market value.

•  Valuation is used by financial market participants to determine the price they are
willing to pay or receive to effect a sale of a business.
 Valuation Approaches

Income Approach

Market Approach

Cost Approach
 Income Approach

• The Income approach methods determine the value of a

business based on its ability to generate desired
economic benefit for the owners. The key objective of
the income based methods is to determine the business
value as a function of the economic benefit.
• Measures the cash flow associated with the ownership of
the asset
• The value is based on the net present value of expected
future income streams from the ownership of the asset.
Income Approach
 Market Approach

• The Market approach based valuation methods establish the

business value in comparison to historic sales involving
similar businesses.
• Based on arms-length transactions of comparable assets.
• Studies transactions in the current marketplace
• Identifies transactions that are comparable to the business that
is the subject of the valuation
• Depends on:
 Appropriate comparable transactions
 Adequate information from the publically traded guideline companies.
 Cost Approach
• The Asset approach methods seek to determine the business value
based on the value of its assets. The idea is to determine the business
value based on the fair market value of its assets less its liabilities.
• Focuses on the value of the underlying assets of a business
• Real estate
• Machinery
• Equipment. 
• This approach to value is useful for businesses that are considered
“asset rich”; possessing undervalued real estate or a great deal of
machinery and equipment.
 Business Valuation Methods

1. Profit multiplier

2. Comparables

3. Discounted cash flow method

4.  Asset valuation
 Profit multiplier

• In profit multiplier, the value of the business is calculated by multiplying its profit.

• For example, if your company’s adjusted net profit is $100,000 per year, and you use a
multiple like 4, then the value of the business will be calculated as: 4 x $100,000 = $400,000

• From the potential buyer’s viewpoint, this means that as long as the business continues to
make profits at the same level, they will get roughly $100,000 per year for the $400,000
investment, i.e. a 25% return.

• After four years they will get the full return on the investment. Compared to the bank or
other investments this is a highly profitable return. The profit multiplier method is also
known as the Price to Earnings or P/E Ratio, the price being the value of the company and
the earnings being the profit that the company generates.
 Profit multiplier (Cont)

• Determine the multiple :

• If pre-tax profit is used, commonly applied profit multiples for small businesses would be
between 3 to 4 and occasionally 5.

• The P/E multiples may be applied higher for larger publicly traded companies, normally
anything from 7 to 12 and in some cases, when they have high growth potential, even more.
This is one of the main reasons why large corporations can acquire smaller business and
instantly revalue them at a higher price.

• Obviously, the multiple that you will use have a huge effect on the valuation of the company. A
larger business with a track record of good profits and with several potential buyer is likely to
value by a higher profit multiple.
 Profit multiplier (Cont)

• EBIT :
• For some companies it is wise to make further corrections in a profit multiplier
calculation, such as EBIT or Earnings Before Interest and Tax.
• This is the adjusted profit that your company makes without the effect of tax and interest.
The EBIT calculation is frequently used when a business is valued or sold based on any
debts and surplus cash removed from the balance. The EBIT gives a demonstration of the
earnings of the business without the destabilizing effect of debts or surplus cash balance.
• You may be thinking why are valuations calculated without any tax?
• The reason is that once the company is merged into a larger group or corporation, the tax
position of the group as a whole may be different. The valuation is agreed based on the
profit after tax and as long as both seller and buyer understand and settled for this, there
shouldn’t be any problem. But remember one thing, if they are based on pre-tax profit,
the multiples used to calculate the value will be less.
 Profit multiplier (Cont)

•EBITDA :
Earnings Before Interest, Tax reduction, Depreciation and Amortization are similar to EBIT. In addition, it explains
that profit or adjusted profit is without the effect of any corrections due to the devaluation of assets or repayment of
any business loans.
Let’s take a hypothetical example :Imagine you own a successful business that is making a profit of $60,000 for few
years. Your business then has an excellent year and takes the profit up to $100,000 and left you with a $50,000
retained profit. A potential buyer gets interested and says he will buy the company based on a 5 time multiple
valuation. It seems like an excellent offer, but you have to consider and clarify a few things before you can accept
the offer. If the 5 times multiple is based on any or all of the following factors, it will be far less attractive.
If the profit is adjusted based on your increased salary, it will reduce the profit by $20,000 each year.
If it was based on an average profit of the last 3 years, which is $53,000 instead of $100,000.
Instead of taking the profit with you, you may have to leave the $50,000 in the business as a part of the working
capital figure.
Based on the above figure, rather than receiving $550,000 after sale, you will walk away with only $265,000. The 5
time multiplier valuation doesn’t look attractive now.
 Comparables

• A common valuation method is to look at a comparable company that was

sold recently or other similar businesses with known purchasing value.

• For example, office and home security companies typically trade at double
the monitoring revenue, and accounting firms trade at one times gross
recurring fees. You can ask around at your annual industry conference and
find out what is the selling price of similar companies in your industry.

• The main problem with the comparables method is that it often leads to an
apples-to-bananas comparison. For example, if you try to compare your
company with similar fortune 500 counterparts, you will be disappointed.
 Discounted cash flow method

• The discounted cash flow method is similar to the profit multiplier method.

• This method is based on projections of few year future cash flows in and out
of your business.

• The main difference between discounted cash flow method from the profit
multiplier method is that it takes inflation into consideration to calculate the
present value.
 Discounted cash flow method
(Cont)
• Present value :
• Present Value (PV) is today’s value of the money you will collect in the future.
Let’s look at another example to understand how it works.
• Let's think that I’m offering you $1000 now, or $100 a year for 12 years (starting
next year). Which would be a better offer for you?
• You may think that $100 for 12 years is a much better offer (12 x $100 = $1200),
i.e. $200 more. However, you have to take inflation rate into consideration. To
make the calculation simple, let’s assume an inflation rate of 5%, so the $100 that
you are going to get next year is equal to circa $95 this year.
• Take a look at the table below, the $100 you will get the following year will be
worth even less and after 12 years the present value of $100 will only about $56.
 Discounted cash flow method
(Cont)

• As you can see the installment offer seem much better offer at first, but after inflation
calculation, it adds up to only $886. Some may think it’s still an attractive offer, but there is
something else to consider
 Discounted cash flow method
(Cont)
• Opportunity cost :

• If you have received $1000 today then you could have invested the money in
something profitable and get a good return every year. With $1000 upfront
you can invest and get a return, but with only $100 you don’t have that
opportunity, this is called the opportunity cost.

• If you had invested $1000 in something profitable and receive a flat return of
10%, within 12 years your money would have grown to $2881, the amount
would have a net present value of $1605. You have to take all of these factors
into account with a discounted cash flow valuation.
 Discounted cash flow method
(Cont)
• How it is calculated :
• You need to estimate the cash revenues coming into the business and expenditures going
out of the business for a number of years into the future to calculate a discounted cash
flow valuation. Taking the expenses out of the profit will give you each year’s net cash
flow. Apply an accurate discount rate (also understood as the cost of equity) to each
year’s figure to get the net present value of the future profit. This gives the discounted
cash flow.

• The potential buyer can compare your business against other investment choices that they
may have, each with their own different levels of risk and return. Just like the profit
multiplier method, this method also comprises a lot of details. Considering inflation
and risk, what level of discount rate to apply for each year, how many years to calculate,
and should you consider the net present value of the business at the end of the period
(known as "terminal value").
 Asset valuation

• With this method, it’s not the profit generating capabilities of your business;
rather than the net value of the assets in your business. If everything in the
business was sold and all debts were paid, this value would be achieved.
• The net asset value of your company is the total market value of all the
assets it holds, such as equipment, machinery, computers, cars and
properties; subtracting the value of any liabilities, such as debts, leases,
finance or other money or equipment owed. Basically, if you sold all your
assets and paid all your debts, you will be left with net asset value (or "book
value").
• Applying asset valuation is generally more realistic if your company has a
large amount of assets and/or its long term revenue generating capabilities
are limited.
 Asset valuation (Cont)

• Market value :
• You can calculate the book value of an asset by deducting any
depreciation from its original price. The assets that the business owns,
your company’s accounts will show the book value of those assets.
However, the market value of those assets might be different.

• Your business has to arrive at the market value of its assets to reach the
net asset valuation. This will require you to hire a CPA or qualified
Appraiser to assess the value of the properties.
 Other valuation aspects

• Surplus cash and long term debt :

 Businesses are generally valued without considering any surplus cash or long term debts. Valuation
works on the basis as if there is no surplus or debt, the actual selling price is then adjusted to take them
into account.
 For example, imagine that a business valued at $500,000 has debts of $100,000. The buyer may offer to
pay $400,000 for the business and accept the $100,000 debt. This is basically the same result if the
seller pays the $100,000 debt and sells the business for $500,000.
 You may have seen in the news that a business being bought for only $1 and wondered how and why?
 This happens when a company has huge debt and can’t afford to repay. If any buyer purchases the
company, they have to pay the debt. So if the company has $1 million of debt and sold for $1 that
means the business is costing the buyer $1,000,001
 For any contract to recognize as valid, there needs to be some give-and-take of value. It’s called the
consideration.
 Other valuation aspects
(Cont)
• Surplus cash and working capital :
Any company needs a certain amount of working capital to function for a reasonable period into the future,
any excess amount is considered as surplus cash. The amount differs from business to business and the
exact figures have to be discussed and agreed between you and the buyer.

If your business has a large cash surplus, then you may go through with the sale process and follow a tax
efficient way to take out the cash, but be careful there are drawbacks.

Firstly, as a part of the business sale, the buyer may be ready to buy this cash from you. To compensate for
their trouble, they will pay you less than its actual value, for example, for every $1, they may pay 90c.

Secondly, if you want to take advantage of the tax benefits, you have to comply with a certain restriction
on how much money you can take out of the company.
 Other valuation aspects
(Cont)
•Goodwill :
When it comes to the valuation of your business, goodwill points out to the adjustment between the
calculated value of your business and its net assets. So if the market value of your business is $1
million but actually holds only $600,000 worth of assets, the rest $400,000 of value belongs to
goodwill.
If the value of your company is less than the value of its assets, then the difference between the two is a
minus number and become negative goodwill. If your business has a lot of assets, such as property or
land, the negative goodwill can occur. So use an asset based approach when valuing your business.
The buyer decides which method of valuation he wants to apply to your business. If they decide your
business is strategic, you will get a handsome profit for your company, otherwise you may get less then
you have hoped.
I’m confident that these valuation methods will be really useful for you when you start the valuation of
your business. There is a saying in the capital industry "the real value of a company is only what a
buyer is willing to pay for it". In other words, the condition of the business, the market, how skillfully
you attract the investors and negotiate with them all determines the value of your business.
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