Venture Capital Valuation

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6、tLICENSE AGREEMENTContentsIntroductionThis sheetAssumptionsPrimary data entry sheetSimple ModelPrimary report sheetIntroductionVenture Capitalists (VCs) are regularly presented with valuation challenges. Since the projects they are investingin rarely have a reliable external valuation (such as the p

7、ublicly quoted market price for a company listed on astock exchange), the VC is on his or her own in attempting to value a potential portfolio investment.To complicate things further, the most popular valuation tools for established companies or for projects withpredictable revenue streams are probl

8、ematic when applied to early-stage companies. Discounted cash flowmight be an ideal tool for valuing a mature company with stable cash flow, or an investment expected to producepredictable cost-savings or revenue improvement. Applying DCF to start-up companies that have a significantchance of either

9、 failure or explosive success, and where business plan estimates of future results arenotoriously unreliable, is not likely to be terribly effective.Similarly, while a late-stage private company could be valued by comparing it with similar publicly tradedcompanies, the comparable companies for an ea

10、rly-stage investment are likely to be privately held themselves,with only limited use for establishing a reasonable valuation.An additional concern with conventional valuation techniques is that they ignore a key element of the VCbusiness model: the exit. A portfolio manager of a mutual fund may hol

11、d his Microsoft shares indefinitely, and abusiness manager is making a capital investment for its returns over an expected useful economic life. A VC,however, typically expects to exit her investment within a fairly short time frame (typically two to five years).The Venture Capital Method: Discounti

12、ng Exit ValueThe Venture Capital Method involves estimating an achievable exit value for the investment, discounting that topresent value, and determining what percentage of equity the VC will need to hold at the time of exit in order toachieve their required rate of return. Once that has been deter

13、mined, the VC can adjust this percentage for anyexpected dilution (e.g. from further rounds of financing or options set aside for employees) and determine howmuch equity she needs at the time of investment.Example 1: A Venture Capitalist is considering investing $10 million in a start-up venture. Sh

14、e estimates thatat the end of year 3 the company will generate $15 million in EBIT and will be ready for an IPO, at which pointshe expects to sell her shares. IPO multiples for this sort of company have typically been roughly 8x trailingyear EBIT. Her investment hurdle rate is 30% p.a. No further di

15、lution is expected. How much equity must shereceive for her investment?Dollar amounts in Millions FormulaIPO Value $120$15 EBIT 8x IPO multiplePresent Value$54.60$120/(1+30%)3Required equity at Exit 18.30%10/54.6Thus, in order to earn a 30% annual return over three years, the VC must receive 18.3% o

16、f the equity in exchangefor her $10 million investment.Venture Capital ValuationINTRODUCTIONVenture Capital ValuationINTRODUCTIONVenture Capital ValuationINTRODUCTIONAdjusting for DilutionVCs have an additional challenge compared with investors in mature companies or managers deciding whetherto go a

17、head with a capital investment project. Most entrepreneurial firms do not raise their entire venturefunding at one time. Rather, funding is raised in separate stages, each one of which will involve a separatevaluation and may include different VCs as investors. In addition, many entrepreneurial firm

18、s provide asignificant amount of options to attract and motivate managers and other key employees. Thus, in determininghow much equity to receive at the time of investment, the VC must often take dilution of that equity into account.Example 2: Let us assume that in the above example, an additional r

19、ound of financing would be required at thebeginning of year three. $10 million would have to be raised. Lets also assume that these investors will need asomewhat lower rate of return (20%) because the venture is at a more mature stage. We would calculate theirrequired equity stake as follows:Dollar

20、amounts in Millions FormulaIPO Value $120$15 EBIT 8x IPO multiplePresent Value$100$120/(1+20%)1Required equity at Exit 10%10/100So, the equity of the company will have to be increased by 11.1% in order for the new investors to have a 10%stake. This will dilute the investment of the first round VC, s

21、o that in order to have 18.3% at exit she will have toreceive 20.3% at the time she invests.Example 3: Now suppose that management wishes to award certain employees with options. These optionswill be issued at the same time as the second round of financing, and will give employees the right to buyeq

22、uity that will equal 15% of the company after that round is complete. How will this affect the required stakesof the original VC investor?To answer this, we must first assess the needs of the second round investors, since that will affect the totaldilution suffered by the original VC. These investor

23、s require a 10% stake at the time of the IPO. The options willdilute them by 15%, so we divide 10% by (1-0.15). They will require an initial stake of 11.8%.Now we can address the dilution of the original VC. Her investment will be diluted by 11.8% by the second roundinvestors and then by a further 1

24、5% by the employee options. Thus, to calculate how much she needs to receivein order to have 18.3% at exit we calculate as follows: 18.3%/(1-0.15)/1-0.118). She will require a 24.4% stake.DirectionsDeveloped for use with The Venture Capital Method - Valuation Problem Set (HBS Case 396-090)Note About

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28、sion rather than to illustrate either effective or ineffective handling of anadministrativesituation. Formatted for the HBS Toolkit by Jon B. DeFriese, MBA 00 and Chad Ellis, MBA 98.Copyright 1999 President and Fellows of Harvard CollegeInvestment RoundsStage 1Stage 2Investment Amount$5.0$0.0Required Stage 1 ROR50.0%30.0%Years to Terminal Stage5.03.0Shares outstanding before investment1,000,000Terminal StageTerminal Management Share0.0%Terminal Sales$100.0 MMTerminal Net Margin5.0%Terminal PER20.0 XTerminal Value of Enterprise$100.0 MMReturn of Stage