Transcript Introduction to Business Valuation

May 22, 2000
Valuing an E-Business and the
Incubator’s Contribution
Quantitative and Qualitative Considerations
Michael Wierwille, Principal
Jim Wilson, Director
Financial Advisory Services
14th International Conference on Business Incubation
I.
Introduction
II.
Valuation 101 - Introduction to Business Valuation
III.
Valuation 999 - Valuations in the New Economy
IV.
The Role of the Incubator as a Venture Capitalist
V.
Case Study
VI.
Implications for the Incubator's Goals & Objectives
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I.
Introduction
II.
Valuation 101 - Introduction to Business Valuation
III.
Valuation 999 - Valuations in the New Economy
IV.
The Role of the Incubator as a Venture Capitalist
V.
Case Study
VI.
Implications for the Incubator's Goals & Objectives
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Accepted Valuation Standards
• Fair Market Value
"The amount at which property would change hands
between a willing seller and a willing buyer when
neither is acting under compulsion and when both
have reasonable knowledge of the relevant facts."
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General Factors to be Considered in
Valuing a Business Interest
• Whether or not enterprise has goodwill or other
intangible value.
• Sales of the stock and size of the block of stock to be
valued.
• The market price of stocks of corporations engaged
in the same or similar lines of business having their
stocks traded in a free and open market, either on
an exchange or over-the-counter.
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General Factors to be Considered in
Valuing a Business Interest
• The nature of the business and the history of the
enterprise from its inception.
• The economic outlook in general and the condition
and outlook of the specific industry in particular.
• The book value of the stock and the financial
condition of the business.
• The earning capacity of the company.
• The dividend-paying capacity of the company.
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Sources of Benchmarking Information
•
•
•
•
•
•
•
Robert Morris Assoc. - Annual Statement Studies
Licensing Databases
Analyst Reports
Standard & Poors Compustat Services, Inc.
Trade Associations
US Government
Trade Publications (Business 2.0, Daily Standard, Red
Herring, etc.)
• Data Sources (Media Metrix, Neilson/Net Ratings)
• Others (PwC, on line news letters, etc.)
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Stages of Development
• Stage I (Start-up) - Ventures have no product revenues and
little expense history. This stage typifies companies with an
incomplete team but an idea, business plan, and the
beginnings of product development.
• Stage II (Pilot Project) - Product development continues,
significant expenses are incurred, team expanding, but no
product revenues generated.
• Stage III (Roll out) - Ventures have limited product revenue,
proving technology, concept and market potential.
• Stage IV (Expansion) - Technology and concept applied to
market, company has product revenues.
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Start-Up Business Valuations Can Use a
Combination of Three General Approaches
• Cost Approach

Uses the valuation information to restate the asset at fair
market value
• Market Approach

Gathering data to value developing assets
• Income Approach

Connects data to value of developing assets
• Scenario Analysis

can be incorporated into market and income approaches to
add depth to the analysis.
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The Cost Approach
Uses the Concept of Replacement
•
•
•
•
Economic Net Worth
Adjust Balance Sheet to Current Market Value
Restate both Assets and Liabilities
Limitation - does not easily Capture "Intangible"
Value
• Cost to Reproduce plus Required Return
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Value Spectrum
250
225
200
150
Replacement Cost
of Fixed Assets
125
100
50
Orderly Liquidation Value of Fixed Assets
25
Forced Liquidation Value of Fixed Assets
0
Scrap Value of Fixed Assets
50
100
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150
200
The Market Approach
• Uses Actual Market Derived Data
• Sources of Information

Public Companies


Private Companies



Same or Similar Lines of Business
Direct Transactions
Metric Databases (Media Metrix, Neilson/Net Ratings)
Industry Analysts
Compare and Correlate Subject Company to Market Comparable
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Income Approach
• "The fair market value of an ongoing business is the
present worth of its expected cash flows.”
• Factors Impacting the Discount Rate



Business Risks
Financial Risks
Investment Risks
• Residual Value is Calculated
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Required Rate of Return
75%
50
25
0
Stage I
Stage II
Stage III
Stage of Development
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Stage IV
Scenario Analysis Can Add Depth to
Market and Income Approaches
• Identify the various alternative outcomes (i.e. success, failure,
holding pattern, etc.) and sub-scenarios as appropriate.
• Calculate value based on each scenario (either through market
or income approach).
• Estimate perceived probability of occurrence for each scenario.
• Weight each scenario value by the assigned probability and sum
the weighted values.
• Scenario variables can include market multiples and company
metrics.
• Scenario Analysis may be particularly insightful in opportunities
with high payoff/low payoff potential.
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I.
Introduction
II.
Valuation 101 - Introduction to Business Valuation
III.
Valuation 999 - Valuations in the New Economy
IV.
The Role of the Incubator as a Venture Capitalist
V.
Case Study
VI.
Implications for the Incubator's Goals & Objectives
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Valuations In The New Economy
A. Cost Approach:
Intangible asset values are substantially greater than the cost shown on
the books or the historic cost to create or reproduce:
I. Time to Market
II. Synergy
III. First Mover Advantage
IV. Networking/non-linear value effects
V. Various Other Intangibles such as; customers, web site traffic,
employees, names, URLs, technology, content and/or distribution
agreements, etc.
Provides insights to the “value drivers” of a company, but does not
generally provide meaningful results related to company value.
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Valuations In The New Economy (cont’d)
B. Market Approach:
• Traditional approach considers earnings/cash flow, assets, etc. Publicly
traded
comparable companies and startup entities generally have:
I. No current earnings or cash flow
II. Intangible Assets not shown on Balance Sheet
III. Huge and varied growth potential
• Market multiples are generally based on industry metrics. Revenue and
visitor
multiples are common.
Identifying good comparable companies and making adjustments for
differences to subject are key and can be challenging.
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Valuations In The New Economy (cont’d)
C. Income/Discounted Cash Flow (“DCF”):
I. Limited positive income or cash flow expected during the projection
period.
II. Values are extremely sensitive to growth and risk assumptions
III. Various potential scenarios oftentimes exist with significantly varied
value conclusions with the spectrum of potential outcomes
IV. Scenario analysis allows you to manage these limitations.
Best Available Approach especially when considered in conjunction with
scenario analysis.
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Dot.com Valuations - General Considerations
• Market Leadership
• Barriers to Entry
• Network Effects
• Complementary Products
• Management
• Differentiation Potential
• Ability to Adapt
• Scalability
• Key Resource; Access to People
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Risk Assessments Affect Pre-Money
Valuations
•
•
•
•
•
•
•
Team Risk
Business Strategy Risk
Product/Technology Risk
Market Risk
Operations Risk
Financial Risk
Marketability / IPO Risk
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Asset Inventory at Entrance
•
•
•
•
•
Determine stage of company development.
What is driving the value of the business at the respective stage?
Focus on core Intangible Assets
Customers (members, unique visitors, etc.), content and distribution
agreements, technology and work force are important intangible assets.
Customer statistics (retention, stickiness and conversion rates) provide
valuable insights to value.
Different Development stages have different key intangibles.
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Dot.com Valuation Metrics
•
•
Numerous Metrics or a combination of metrics may be applicable:

Unique Visitors

Registered members

Page Views

Number of Customers and/or Life Time Value of the Customer

Retention/Churn Rates

Orders

Revenue

Gross Profit

Net Income
Key Valuation Metrics vary by Internet business segment (e.g.):

ISP - Subscribers, Revenue, Retention

Community - Registered members, Retention, page views

Portals - Unique visitors, Page Views

E-tailers - Orders, Revenue , Margins, page views to purchases

Content/Destination sites - Unique visitors, Page Views, members

Infrastructure - Orders, Revenue, Gross Profit, Market Share
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Dot Com Valuation
Forecast Internet Market Multiples
•
•
•
•
Bubble value: Current market prices for comparable entities may not reflect Fundamental
Value or the value one can expect to obtain at IPO.

Momentum buying

Limited Supply

Speculation
Realistic value: Market Price may Reflect Real Option Value (Weighting of the various
alternative scenarios that may occur).
Comparable public companies metrics may not apply directly to a subject entity

May reflect first mover advantage into a market segment

Differences in size, growth potential, risk

True comparable companies may not exist
Limited Float may imply erroneous total firm value
Be Careful - The future may be substantially different than the past, both in
terms of the value per metric and the applicable metric.
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Summary of Dot Com Valuation
Approaches
•
Difficult to apply the traditional Market and Cost Approaches. This generally results
in valuations based on an Income Approach over a short time period with a
forecasted exist value.
•
Scenario Approach: Weighting the results of a variety of scenarios over an
extended time period based on varying assumptions related to the size, market
share, competitors, etc.
•
Market Approach: useful on a forward looking basis.
•
Cost Approach: provides insights related to value drivers.
•
Transaction Approach: What other investors have paid for preferred stock and the
value implied by the transactions for the business and its various equities.
Scenario Approach with Income Approach most applicable. Other approaches
can provide important insights.
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I.
Introduction
II.
Valuation 101 - Introduction to Business Valuation
III.
Valuation 999 - Valuations in the New Economy
IV.
The Role of the Incubator as a Venture Capitalist
V.
Case Study
VI.
Implications for the Incubator's Goals & Objectives
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Pre and Post-Money Value Defined
• Pre-Money Valuation

•
The pre-money value of a company is negotiated between
entrepreneurs and venture capitalists during a financing
round. Venture capitalists evaluate the team's idea, skills,
experience, business plan, and progress toward their goals.
The pre-money valuation is ascribed to the venture prior to
cash being received.
Proceeds

Proceeds (cash) received during a round of financing should
propel a venture to a future point where additional capital
can be raised at an increased valuation.
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Pre and Post-Money Value Defined
• Post-Money Valuation
 Post-money valuation, the valuation term most
entrepreneurs are familiar with, is a company's
value after cash has been infused into the
company. It is the value placed on the venture by
the financing transaction.
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Intangibles Contributed by the Incubator
• Incubator Personnel
• Relationships with Vendors, service providers, ties to other
start-ups (“keiretsu”)
• Sharing Professional Services
• Credibility with investors
• Expedite Time to Market
• Facilities and Equipment
• What is the value of the intangible contribution and how do
you measure it?
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I.
Introduction
II.
Valuation 101 - Introduction to Business Valuation
III.
Valuation 999 - Valuations in the New Economy
IV.
The Role of the Incubator as a Venture Capitalist
V.
Case Study
VI.
Implications for the Incubator's Goals & Objectives
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Company Description
• Internet B to C specialty retailer, commerce and
community site
• Founded May 1999
• 10 Full-time Employees at founding
• No Revenues, No Income, Initial Web Site, Limited
Employees (Stage #1)
• Bricks & Mortar company provided name, fulfillment and
partial funding
• Previous owners provided both a web site that was
adapted for the company and some fixed assets
• VCs provided seed funding
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What Incubator Adds to Value of
Tenant Firm Value
•
Tangibles and Intangibles:




Credibility and Contacts with service providers (lawyers,
accountants, public relations, recruiters, funding sources)
Incubator Assets; Leadership, Personnel, Facilities, etc. at
favorable terms
Relationships with other Tenants (“keiretsu”) and access to
strategic combinations (@Home & Excite)
Decreased Time to Market (lowers total cost and increases
potential market share)
•
Access to VC Funding
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Scenario Analysis - Simplified Example
Perceived
Probability
Scenarios
Favorable Exit within 2.5 years
Liquidation within 2.5 years
Percieved probability of Exit after 3 years
High exit value after 3 years
Moderate exit Value after 3 three years
Low exit value after 3 years
Concluded Multiple
20%
40%
40%
30%
30%
40%
Revenue
Multiple
Weighted
Value
4.0
-
0.8
-
4.0
3.0
2.0
0.5
0.4
0.3
2.0
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Dot.com Valuation
IPO Value ($ 000)
Projected Revenue
Revenue Multiple
Implied Value
Projected Unique Visitors
Unique Visitor Multiple
Implied Value
As Tenant at
IPO
As Stand Alone
at IPO
$
$
$
50,000
2.0
100,000
$
2,500
40
100,000
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$
63,000
1.5
95,000
$
3,200
30
95,000
Measuring the Intangible Contribution
($ 000)
Year 2
Year 1
As Stand Alone
Operating Income
Pre-money IPO Value
Net Cash Flows
Discount Rate - 40%
PV of Cash Flows
$
(10,000)
$
(20,000)
$
$
$
(10,000)
.70
(7,000)
$
$
$
(20,000)
.50
(10,000)
Value as Stand Alone
$
13,000
Year 2
Year 1
As Tenant
Operating Income
Pre-money IPO Value
Net Cash Flows
Discount Rate - 35%
PV of Cash Flows
$
(10,000)
$
(17,500)
$
$
$
(10,000)
.70
(7,000)
(17,500)
.55
(9,600)
Value as Tenant
$
28,400
Incubator Benefit
$
15,400
$
(Tenant less Stand Alone)
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Year 3
$
$
$
$
$
(20,000)
95,000
75,000
.40
30,000
Year 2.5
$
$
$
$
(10,000)
100,000
90,000
.50
45,000
Measuring the Total Benefit Contributed by
the Incubator ($ 000)
Contributed Assets
Present Value of
Estimated Benefit
Intangible Contributions
Credibility
Contacts
Leadership
Keiretsu
Time to Market
Decreased Risk
Increase Extendibility/Flexibility
$ 15,400
Tangible Contributions
$
$
Professional Services
Facilities
Non-Cash Total
Contribution
75
25
$ 15,500
Other Contributions
$ 2,000
$ 17,500
Funding/Cash Contributed by Incubator
Total Contributions
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Total Ownership Due to Incubator
($ 000)
Value with Incubator
(Post Money Valuation)
$27,000
Total Benefit Contributed by
Incubator (All Forms)
$17,500
% Ownership Due Incubator
(Ratio of Benefit Contributed
to Post Money Valuation)
65% (approx.)
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I.
Introduction
II.
Valuation 101 - Introduction to Business Valuation
III.
Valuation 999 - Valuations in the New Economy
IV.
The Role of the Incubator as a Venture Capitalist
V.
Case Study
VI.
Implications for the Incubator's Goals & Objectives
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Why do this?
•
•
•
•
Incubator Funding
Tenant Recruitment
Negotiation of Equity Positions
Measures the Performance of the Incubator through
the Success of its Tenants
• Demonstrates the Incubator's Contribution to the
Community
• Accounting Issues
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Compensating the Incubator
• Common or Preferred Stock
• Royalty Agreement on Intellectual Property
• Back end (“Phantom Stock”) deal
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