Private and Confidential
Private Equity Workshop
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1Private and Confidential Not for Circulation
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Corporate Bridge Academy
Discussion Topics
Valuations
Pre-Money Valuation
Post-Money Valuation
Factors that impact valuation
Valuation Approach
Recent Transactions
Public Comparables
Discounted Cash Flow
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Investor-Return
Valuation Triangulation
Summary
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Valuations
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3Private and Confidential Not for CirculationPrivate and Confidential Not for Circulation
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Valuations
Pre-Money Valuation
Value of company before equity investment is made. This figure is determined via a negotiation between investors and the company
Post-Money Valuation
Value of company after the equity investment has been made. Equal to pre-money value + the amount of equity invested
Valuation Approach
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Recent transactions
Publicly traded comparable companies
Discounted cash flow analysis
Investorreturn analysis
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All four methods should be used to arrive at a middle ground
Factors that impact valuation
Size of opportunity
Large growing markets are most attractive
Ability to generate large gross margins is a key driver
Near term opportunities will be valued higher
Stage of company
How complete and strong is the team
How complete and feasible is the product/technology
Has the company achieved traction (i.e. revenues)?
Market/Environment
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Market/Environment
Competitiveness in the target market
Public/private market fluctuations
Competition to get into the deal
Other
Lawsuits?
Regulatory/government
Capital Structure (prior financings)
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Recent Transactions
Review recent venture transactions that are comparable (market sector, stage of company, etc.)
Clearly depicts a quantitative state of the market and helps determine the current market clearing price
Difficult to identify pure comparables (often venture investments deal with new markets and technologies). Also, valuation is rarely disclosed for early stage deals
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Company Type Closing DatePre Money Value ($mn)
Capital Raised ($mn)
Post Money Value ($mn)
Share of company sold
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Date Value ($mn) ($mn) Value ($mn) company soldABC Company Apparels 8/1/2007 10.5 9.76 20.26 48.2%DEF Company High end fashion garments 3/3/2006 13.2 9.00 22.20 40.5%GHI Company Children clothing 8/13/2007 14.3 4.60 18.85 24.4%KRR Company General fashion garments 5/22/2007 9.8 8.86 18.61 47.6%JKL Company Ladies Apparel 2/11/2006 22.8 11.96 34.76 34.4%MNO Company Gents Apparel 4/15/2007 6.9 2.22 9.12 24.4%PQR Company Gents Apparel 7/17/2007 15.5 5.86 21.31 27.5%
Mean 13.3 7.5 20.7 35.3%Median 13.2 8.9 20.3 34.4%
Public Comparables
Review multiples & valuations of publicly traded companies
Provides a quantitative view, on key metrics, as to what values the public market gives to a certain level of revenue, profit, etc.
Results of this analysis must be discounted for:
self-selection of public companies (what about the 30 that failed?)
illiquidity
Discount for IPO timing
Public market multiples fluctuate rapidly (e.g., early April 00)
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Public market multiples fluctuate rapidly (e.g., early April 00)
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Company Description Terminal Value ($mn)
2008 Revenue Estimate ($mn)
Terminal Value / Sales Ratio
RZ Retail Apparels 36.0 13.0 2.8 Ink Fashion High end fashion garments 140.0 45.0 3.1 BKZ Children clothing 26.0 7.0 3.7 Blaze Clothings General fashion garments 1,708.0 285.0 6.0 MK Jimmy Ladies Apparel 2,983.0 345.0 8.6 KXY Gents Apparel 7,290.0 710.0 10.3
Mean 2,030.5 234.2 5.8 Median 924.0 165.0 4.9
Discounted Cash Flow
Developing a forecast of the companys revenues and costs to calculate a net present value (NPV) of its future cash flows
Can be extremely robust if done properly
A thorough knowledge of the business/market must be developed to determine the appropriate assumptions (revenue, ramp, penetration, costs, etc.) Selecting an appropriate discount
Steps in DCF
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Step 1: Estimate the VCs exit date
Step 2: Forecast free cash flows to equity until the exit date
Step 3: Estimate the exit price, use it as TV
Step 4: Choose a high discount rate (VC discount rate)
Step 5: Discount FCF and TV using this discount rate
Step 6: Calculate VCs Stake
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Steps in DCF
Step 1: Estimate the VCs exit date
VC money is not long-term money: Typically, the VC plans to exit after a few years
Estimate the likely time at which the VC will exit the investment
This determines your forecasting period
The VC usually will have a specific exit strategy in mind:
IPO
Sale to a strategic buyer (e.g., a larger firm in the industry)
Restructuring
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Step 2: FCF to (Levered) Equity
Forecast FCF to (levered) equity (or Equity FCF) until exit
These are cash flows received by equity-holders (VC included)
EFCF=Net Income + Dep. - CAPX DNWC
Principal Repayment + New Borrowing
Need to forecast the firms operations. May be very uncertain
Cash flow forecasts are the key to sound valuation
Oftentimes, these cash flows are zero or negative
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Steps in DCF
Step 3: Exit Value
Forecast the companys value at the exit date (i.e., forecast the companys value at the IPO or in a sale).
Use this value as the Terminal Value
Typically, this value is calculated by estimating the companys
earnings, EBIT, EBITDA, sales or customers (or other valuation-relevant figure)
and applying an appropriate multiple
The multiple is typically based on comparable publicly traded companies or comparable transactions
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transactions
Step 4: VC Discount Rate
Determine a rate for discounting the FCF to leveraged equity and the exit or terminal value back to the present
Typically, discount rates range from 25% to 80%:
lower for investments in later stage or more mature businesses
higher for seed investments
These discount rates are typically higher, and oftentimes much higher, than those calculated using a CAPM-based type model
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Steps in DCF
Step 5: Valuation (Pre-Money)
Use the discount rate to estimate:
the PV of all FCF to levered equity
the PV of the Exit Value
This gives the Pre-Money Value of the company.
This is the value of the firm before the investment is made
Go ahead only if this is positive
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Go ahead only if this is positive
Step 6: VCs Stake
Post-Money Value: Firm value after the VC has injected funds.
Post-money value = Pre-money value + VC Inv
It is what an investor would pay for the firm up and running
Post-funding, VCs stake is worth a fraction of the post-money value for an equity stake the VC should be willing to pay:
VC % Stake * Post-money value
This implies:
VC % Stake = VC Investment / Post-money value
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Discounted Cash Flow: Example of Super Fashion
Step 1: Exit Date
The idea is for Oz.com to go public in 5 years.
Step 2: Forecast FCF to (Levered) Equity
Five-year forecast of FCF:
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Year 0 Year 1 Year 2 Year 3 Year 4 Year 5Free Cash Flows (7.0) 1.0 3.0 5.0 10.0 15.0
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Super Fashion will not have any debt, will not require additional equity investments.
Step 3: Exit Value
In five years, VC forecasts Super Fashion Net income to be $5M.
Today, publicly traded companies in the same business as Super Fashion trade at price-earnings (P/E) ratios of about 20x times.
Estimate an exit value of 20 * 5 = $150M.
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Year 0 Year 1 Year 2 Year 3 Year 4 Year 5Free Cash Flows (7.0) 1.0 3.0 5.0 10.0 15.0 Terminal Value 100.0
Discounted Cash Flow: Example of Super Fashion
Step 4: VC Discount Rate
The VCs target rate of return for this investment is 50%
Step 5: Valuation
Five-year forecast of FCF:
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Year 0 Year 1 Year 2 Year 3 Year 4 Year 5Free Cash Flows (7.0) 1.0 3.0 5.0 10.0 15.0 Terminal Value 100.0
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Step 6: VCs Equity Stake
Super Fashion pre-money value = $13.6M.
If the VC injects $7M, Super Fashion post-money value = 13.6+7 = $20.6M,
To invest $4M, the VC will ask for 7M/20.6M = 34% equity stake.
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Total Cash Flows (7.0) 1.0 3.0 5.0 10.0 115.0 Discount rate 1.00 0.67 0.44 0.30 0.20 0.13 PV each year (7.0) 0.7 1.3 1.5 2.0 15.1 PV @ 50% 13.6 PV excluding initial investment 20.6
Investor-Return
The value of the business must be set so that both management and investors generate an appropriate return
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75
100
Series B investor requires 5x = $25MM
Management
$
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0
25
50
Seed investor requires 20x = $20MM
Series A investor requires 10x = $30MM
Seed Investor$1MM
Series A$3MM
Total Value
Required
$ Millions
Series B$5MM
Valuation Triangulation
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$15MM to
Appropriate private company multiple = 2-2.5x revenue
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Must be discounted for: illiquidity selection bias timing
revenue track record
market share
Public multiples are 4-5x NTM revenue
$15MM to $20MM Pre-
Money requirements?investors return
Does the range match the match the
Recent VC TransactionsDevelopmental stage
retail companies selling 35% - 40% of company
for round
Cash Flow DCF Model Valuation RangeRange: $15MM to Range: $15MM to $20MM, depending upon discounting
assumptions
Multiples Analysis
5x to 6x Revenue Multiple for Terminal Value
Valuation
While triangulation is an effective means to compute value, a number of other factors play a role
The negotiated valuation must result in sufficient incentive for current and future management team members
Competition, amongst venture capital firms, drives up the clearing price
Current investor sentiment with a sector (e.g., biotech / life sciences right now)
Structure of the deal (ratchets tied to milestones, etc.)
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At the end of the day, investors and management are on the same team
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