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Valuing Start-Ups Justifying Price Not Fairy Tale Valuations 7 May 2015

CeBIT Presentation v4, 7May15

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Valuing Start-UpsJustifying Price Not Fairy Tale Valuations

7 May 2015

Theory

Practice

Lessons

CONTENT

2

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The asset method values the assets of a business and does not assume a goingconcern

Source: Eric Tachibana

VALUATION METHODS Theory

You are worthwhat you own

You are worth whatyou own in the future

You are worth whatthe market saysyou are worth

1 2 3

Valuation Approaches

3

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Valuing a business based on actual assets is the simplest and most intuitive way;however, it doesn’t work for start-ups and is generally used during liquidations

Assets Liabilities

Current AssetsCashAccounts ReceivablesInventory

Total Current Assets

Current LiabilitiesAccounts PayableTax LiabilitiesProvisions

Total Current Liabilities

Non-Current AssetsEquipmentBuildingsIntangible assets

Total Non-Current Assets

Non-Current LiabilitiesLong-term loansLong-term provisions

Total Non-Current Liabilities

Net Assets

Equity

ASSET APPROACH You are worthwhat you own

You are worthwhat

you own in thefuture

You are worthwhat

the marketsays

you are worth

1 2 3

ValuationApproaches

Theory

4

The image part with relationship ID rId8 was not found in the file.Source: Eric Tachibana

VALUATION METHODS Theory

You are worthwhat you own

You are worth whatyou own in the future

You are worth whatthe market saysyou are worth

1 2 3

Valuation Approaches

DCF* models are premised on the fundamental tenet of corporate finance: thevalue of a company today is equal to the present value of future (but uncertain)cash flows

5

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The discount rate reflects the level of risk and the opportunity cost

NET PRESENT VALUE METHOD

���

� � �

��

� � � �

��

� � � �

− � 0 = Initial Investment� = Cash Flow� = Discount Rate� = Time

NPV Formulas

You are worthwhat you own

You are worthwhat

you own in thefuture

You are worthwhat

the marketsays

you are worth

1 2 3

ValuationApproaches

Theory

So what’s the discount rate?

* DCF = Discounted Cash Flow

6

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Investments in early stage businesses are high risk with more than 50% notreturning the capital initially invested

52%

33%

8%

3% 4%

0%

10%

20%

30%

40%

50%

60%

<1x 1x to 5x 5x to 10x 10x to 30x >30x

3.3 years

3 years

4.6 years

4.9 years 6 years

Distribution of Group-Affiliated Angel Returns

Source: Wiltbank, Returns to Angel Investors in Groups, 2007

INVESTOR RISK You are worthwhat you own

You are worthwhat

you own in thefuture

You are worthwhat

the marketsays

you are worth

1 2 3

ValuationApproaches

Theory

7

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A principal cause is the lack of information at the time of the investment

SeedFunding

AngelFunding

SeriesA, B, C

TradeSale /IPO

Available Information

Low High

LACK OF INFORMATION You are worthwhat you own

You are worthwhat

you own in thefuture

You are worthwhat

the marketsays

you are worth

1 2 3

ValuationApproaches

Theory

BridgeFunding

Source: Efrat Kasznik

8

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The higher the risk the higher the discount rate

Source: Efrat Kasznik, Harvard Business Review; How Venture Capital Works Harvard Business Review: A Method for Valuing High-Risk Long-Term Investments

80%+Seed

50-70%Angel

40-60%Series A

30-50%Series B

25-35%Bridge

15-25%Mezzanine

DISCOUNT RATE You are worthwhat you own

You are worthwhat

you own in thefuture

You are worthwhat

the marketsays

you are worth

1 2 3

ValuationApproaches

Theory

Discount rate: risk and opportunity cost

9

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-0.25

00.25

2.5

10.0

Year 1 Year 2 Year 3 Year 4 Year 5

The NPV* of an early stage venture forecasting a year 1 loss of $250 thousandand a $10 million profit in year 5 is $624 thousand

EXAMPLE

NPV = Net Present ValueSource: www.biz.yahoo.com, extract only

Start-Up Profit Profile, NPV and IRR- in million $ -

Seed investment� = 80%

)

You are worthwhat you own

You are worthwhat

you own in thefuture

You are worthwhat

the marketsays

you are worth

1 2 3

ValuationApproaches

Theory

While VC firms regularly use DCF analysis it is best suited for projects

10

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The price earnings analysis leverages the wisdom of crowds …

Source: Eric Tachibana

Theory

You are worthwhat you own

You are worth whatyou own in the future

You are worth whatthe market saysyou are worth

1 2 3

Valuation Approaches

VALUATION METHODS

11

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… whereby the value of a business should be similar to the value of similar firms,in similar industries

PRICE EARNINGS RATIO

-0.25

0 0.25

2.5

10

Year 1 Year 2 Year 3 Year 4 Year 5 EV atExit

15x

150

Sector P/E*

Application Software 45.5

Asset Management 15.7

Beverages-Brewers 31.5

Biotechnology 102.8

Food Products 15.9

Medical Equipment 44.9

Waste Management 35.5

IT Services 19.1

Source: www.biz.yahoo.com, extract only

P/E Ratios and EBIT Multiples- in million $ -

You are worthwhat you own

You are worthwhat

you own in thefuture

You are worthwhat

the marketsays

you are worth

1 2 3

ValuationApproaches

Theory

Method is best suited for (more) mature, profitable businesses

Theory

Practice

Lessons

CONTENT

13

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Convertibles notes defer the cumbersome negotiation of EV to times when morequantitative information is available

Angel Invest?

End

How?

No

Yes

Not Priced Priced

ConvertibleNote

OrdinaryShares

Source: Efrat Kasznik

ANGEL VALUATION APPROACHES Practice

Angel Investment & Valuation

14

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Angel investors’ valuation of start-ups is driven by the desire to hold a sizeableshareholding

Funds Raised ($)

Valuation ($) Ownership

10%-30%$1.5m*

$300k

* Pre money

Source: Efrat Kasznik

Practice

Angel Valuation Triangle

ANGEL VALUATION APPROACHES

15

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DAVE MCCLURE’S VALUATION MODEL

Revealed by Dave McClure (500 Startups) at a TechCrunch Disrupt Event (2011)

Each point is worth $1 million (‘million dollar points’)

1. Market

2. Product

3. Team

4. Customers

5. Revenue

Question: is IP considered?

Dave McClure’s approach to valuing start-ups is based on 5 simple criteria eachworth a maximum of $1 million

Max valuation is $5 million

Practice

Source: Efrat Kasznik

16

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In the US valuations of start-ups have risen from $2.5 million to $3 million in justover 12 months

START-UP VALUATIONS-US

Source: HALO Report

Practice

Start Up Valuations in the US

USD 3.0mMedian

USD 1.5m1st Quartile

USD 4.0m3rd Quartile

USD 0.3m

USD 10mUSD 2.5mMedian

20132014

17

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Industry

Software 141

Physical 33

Health 11

Other 7

Software (web & mobile)dominates at 73%

Valuation Sought

< $1m 19

$1m - $2.5m 55

$2.5 - $5m 31

Other 88

A large number at 0 or outsideSydney Angels Criteria

Capital Sought

< $300k 51

$300k - $500k 63

$500k - $1m 32

Other 46

3% chance of beingfunded in 2014

START-UP VALUATIONS-SYDNEY ANGELS

At Sydney Angels a majority of entrepreneurs have realistic valuationexpectations of below $2.5 million; angels negotiate valuations down anyway

Practice

Source: Sydney Angels

18

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Assumption

VC VALUATION APPROACH

The VC approach to valuation is exit driven and combines DCF analysis with theP/E method

Practice

15x =P/E Multiple

80% DiscountRate = 20x ROI

50% futuredilution

$10 million

$150 million

~$8 million

~$4 million

Profit in year 5

EV in year 5

Value today

Fully dilutedvalue today

Shareholding: 33.3%

IRR: 194%

Return: 75x

Investment: $2m

Theory

Practice

Lessons

CONTENTS

20

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MISTAKES TO AVOID Lessons

5 per cent of something is better than 100 per cent of nothing

Dos … Don’ts

Do your homework and be prepared tojustify your valuation

Don’t pull a number from thin air

Be realistic Don’t be greedy & alienate investors

Don’t be obsessed and procrastinateFocus on what matters: raise capitalquickly & accelerate growth

No need to raise too muchBalance funding requirement, dilution &time to raise capital

Don’t succumb to a common mistake bythinking: the grass is greener in the US

Concentrate on the environment you aremost familiar with

21

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Dependent on the level of traction a valuation of $1.5 to $2 million is likely toavoid unpleasant discussions

Scientific approaches to valuing start-ups have limited validity;

Start up valuation of $1.5 to $2 million is a safe bet;

Expedite the capital raise process, minimise disruption and focus on what matters: growing the business.

SUMMARY Lessons

Theory

Practice

Lessons

Appendix

CONTENTS

23

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The comparison of enterprise values for start ups and mature businessesoften lead to counterintuitive results

The Valuation Paradox

Characteristics Electrical ServicesProvider

Start-Up

Year of Establishment 1985 2014

Product/service Well defined Proof of concept

Business model Proven Unproven, big dream

Scalability Low Perhaps

Revenues $10 million None

Cash flow Positive, $1.5 million Burn rate $60 thousand p.m.

Profit $1 million None for the next 4 years

Enterprise Value $2 million $2.5 million

Source: Efrat Kasznik

VALUATION COMPARISON Valuation Methods