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AgendaSaturday, July 23rd, 2011
1. The Billion Dollar Club?2. What is Venture Capital?3. Valuation Methodologies4. Valuation in Venture Capital5. Structuring a Fund6. Case Study: MMT
The Billion Dollar Club
The Billion Dollar Club
Airbnb is definitely in the club. The crowdsourced marketplace for turning your apartment into a hotel for a night grew 800 percent last year in nights booked to 800,000. There are currently 60,000 listings, and bookings keep growing by 40 to 50 percent a month. Sublets are next.
The Billion Dollar Club
Square is also in the club. It is raising at least $50 million. Square passed 500,000 card readers and 1 million transactions in May, and is processing more than $3 million a day in mobile payments. COO Keith Rabois told us at Disrupt NYC that Square will do $1 billion in transactions this year, and he thinks it could ultimately do better financially than Paypal (where he was an early executive).
The Billion Dollar Club
Dropbox, the Y Combinator file-sharing startup that only ever raised $7.2 million might end up with the largest valuation in the club, perhaps as high as $1.5 billion or $2 billion. It’s just growing like crazy, with 25 million users saving 200 million files daily. That’s up from 4 million users 18 months ago.
The Billion Dollar Club
Gilt Groupe is already in the club. It closed a $138 million round at about a $1 billion valuation last May. One of the first companies to introduce online flash sales in the U.S., Gilt is on track to do $500 million in revenues this year and has expanded from fashion to food, travel, local deals, and more.
The Billion Dollar Club
Gilt Groupe is already in the club. It closed a $138 million round at about a $1 billion valuation last May. One of the first companies to introduce online flash sales in the U.S., Gilt is on track to do $500 million in revenues this year and has expanded from fashion to food, travel, local deals, and more.
The Billion Dollar Club
Just above this group, is
Pandora (which just went public with a $2 billion market cap),
LivingSocial (with a $3 billion valuation),
LinkedIn (already public, with a $6.3 billion market cap),
Twitter (which is worth anywhere from $3.7 billion to $10 billion),
Zynga (which will be worth north of $10 billionwhen it goes public),
Groupon (which could be worth more than $25 billion) and
Facebook (which is already worth $50 billion and could go as high as $100 billion by the time it IPOs).
Apple
The Billion Dollar Club-Google
Multiples will change with maturity
What is Venture Capital?
Private Equity & Venture Capital“Private Equity” means capital to companies
not quoted on a stock market, in exchange for an equity participation
Venture Capital (VC) is a sub-class of Private Equity characterized by investments made for the purpose of developing, launching, and expanding new products or service offerings
• Seed Fund• Venture Capital • Buyout / Leveraged Buyout • Growth Capital• Special Situation Funds
– Stressed Asset• Real Estate Fund• Infrastructure Funds• Secondary Funds
Type of Alternative Investment Class
Source : Erasmic Fund
Fund Raising Pattern – Life Cycle of a Startup
• Higher returns• Risk capital• Technology driven ?• Capital efficiency • Unlisted companies / PIPE
Key Attributes
How VC’s work
Investor
Investor
Investor
VCfund
Investor
Startup
Startup
Startup
• Fee Structure : 2 :20 model– During commitment period– Post commitment period
• Draw down schedule– Duration– Fund amount
• Alignment of interest– Carry structure– Claw back provision
Deal Structure
Attributes of a Great VC Fund
• Bets on people not trends• Driven by the big idea• Looking for a ‘Winner’• Not afraid of failure• Understand how to manage a portfolio of
risk• Serves as a fantastic coach• Does her best work outside of the board
room• Not waiting for validation from other VCs
In the VC’s Mind• Is this the right team?• What’s the entrepreneur's motivation?• Is this a billion dollar opportunity?• Is it a game changer?• How competitive is the space?• How defensible is the product?• How much is this thing going to take?• How long to maximize value and exit?
Stages of Investment
Stage vs. Return
In the VC’s mind• IRR (Internal Rate of Return)
– Company’s Current and Future Valuation• Comparables (P/E,P/S,…), “Number of”, DCF, …
– What’s The Best Strategy To Create Value• Which are the achievable milestones and what’s the financing
needed ?• When is the break-even expected ? With which margins and
revenues.
– Exit Strategy• Trade sale, IPO, Nth+1 round of financing, ..
• Minimizing Risks– Diluting the investment– Liquidation Preference rights
Valuation Methodologies
Factors Captured in Valuation• Time Value of Money – Value of dollar
today vs. tomorrow• Risk of Cash Flows – Certainty of cash
flows• Growth Potential of Cash flows –
Future potential of business
Valuation Methodologies• Two main valuation methodologies:
– Discounted Cash Flow Analysis (“DCF”)• Current value based on internal cash flows
projections• Adjusts for risk and time value of money
– Multiples• Useful in comparing similar companies • Captures operating and financial characteristics
(e.g. expected growth) in a single number that can be multiplied by some financial metric (e.g. EBITDA) to yield an enterprise or equity value
• Expressed as a ratio
Discounted Cash Flow Analysis• Current Value based on Discounting Projections• Key Components:
– Free Cash Flow– Terminal Value– Discount Rate
• This method works very well for businesses with stable cash flows (i.e. infrastructure, mature businesses)
• For start-ups, however, a DCF does not work as well due to: the volatility of cash flows and difficulty it's often impossible to model revenue correctly, let alone cash flow, and terminal value
DCF Example – Company A
Year 1 Year 2 Year 3 Year 4 Year 5Free Cash Flows 630 662 695 729 766
5% 5% 5% 5%Discount Factor (1+R)^n where R=discount rate and n=year being discounted
1.09 1.19 1.30 1.41 1.54
Discounted Cash Flows 578 557 536 517 498
Sum of Cash Flows 2,685
Perpetuity Value Year 5 Cash Flow x (1+g)/(R-g) where g= perpetuity growth rate7,848
Discounted Perp. Value Year 5 Discount Factor Used5,101
Total Equity ValueSum of Cash Flows 2,685Perpetuity Value 5,101Total Equity Value 7,786
Multiples• Multiples can be applied to a company’s financial
metrics from two sources:– Comparable Companies:
• Implied value in the public markets by analyzing similar companies' trading and operating metrics
• Depends on the level of comparability of the selected publicly traded companies
• Does not include a "control premium" – Precedent Transaction Analysis:
• Multiples derived from comparable precedent M&A transactions
• Reliability depends on the number of precedent transactions and their levels of comparability
• Market cycles and volatility impact on historical• Individual buyer synergies and structure of
transaction will also impact multiples
Commonly Used Multiples• Price / Earnings (“P/E”) – stable services company
• P/E/G (“PEG Ratio”) – extension of P/E; best for fast growing company
• Price / Sales (“P/Rev”)* - brand, negative cash flows
• Price / Book Value (“P/BV”) – banks, insurance
• TEV / EBITDA – removes the affect of capital structure
* Note – in companies with debt, enterprise value is used, where equity + debt equals enterprise value
Valuation in Venture Capital
VCs imperative- 10X in each deal
• The “Portfolio Effect”– Out of Ten Start-ups Funded, with Re 1 each,
• 2 successes at 10x or better 20• 5 ‘OK’ returns at 1.5x to 4x 10• 3 write-offs, total loss of invested money 0• Total Gains on Investment of Rs 10 30
• Venture Capital is fundamentally an institutionalized form of aiming for Outliers!
• Do we know which one is 10X? We expect each one to be 10X, and then pray
Super deal - Venture Capital Perspective
1. Goal - Build a highly profitable, industry dominant company to be taken public or harvested in another way at a high P/E multiple in 5-8 years.
2. Management Team - Well rounded with proven experience in building a company. Team works well together and is led by an industry star. Team must also posses high commitment and integrity.
3. Product - Proprietary product with a sustainable competitive advantage.
4. Market - Clearly identified large and growing market with minimal current and near-term competition
Valuations- What is a Fair Deal?
Not So fair Deal
Current Revenue- 1 crRev. at 5 years - 15 crCo. sold for - 60 cr
Investment made 2 crVC stake 60%VC return 36 crVC return 18 times
Not So fair Deal
Current Revenue- 1 crRev. at 5 years - 15 crCo. sold for - 60 cr
Investment made 2 crVC stake 15%VC return 9 crVC return 4.5 times
Co. grew by 15 times, VC got 18 times
Co. grew by 15 times, VC got 4.5 times
Valuations- What is a Fair Deal?
High sales multiple
Investment made 20 cr
Rev. at 5 years - 15 crRevenue Multiple 10Valuation 150 cr
VC stake 40%VC return 60 cr
Low Sales Multiple
VC return of 3X, not enough
Again, VC return not enough
Investment made 10 cr
Rev. at 5 years - 30 cr
Revenue Multiple 2Valuation 60 cr
VC stake 40%VC return 24 cr
Stake and Investment Lifecycle
What do we need to optimize? Size of the circle or Promoter Stake?
Valuation Soft Parameters
‘We want to raise money and hire some people and build the product. Of course, we will start with market research’
‘We have burnt the midnight oil for last two years to research this need, built the product and have left our jobs a few months ago because we just had to get started’
Valuation Soft Parameters
“We will hire a sales head as soon as we get set. We don’t mind even hiring a CEO”
‘Here is the Sales Head, my co-founder, and I remain the CEO till the company is large enough to attract a professional ’
Deal Structuring
• Types Of deals– Startups– Fresh Equity – Growth Capital– Buyouts – Leveraged Buyouts
• Issues– Performance clause– Dilution– Exit Scenario– Taxation Issues
Investment Deal Structures
• Startup Structure
– Startup aims to raise ~ USD 1 Crore– Proposal
• VC contribution ~ INR 1 Crore for 40% stake• Entrepreneur ~ 60% of share for idea, execution and
delivery
Deal Structure
• Risk faced by VC/ Investor if agreed to this this structure– Split of proceed if venture fails– Split of proceeds if venture succeeds– Investor IRR– Good faith investment from entrepreneur : Skin in
the game– Clause for staying in the venture : vesting
Deal Structure
• Proposed structure from PE/ VC player
Debt Investor Entrepreneur
Debt INR 50,00,000 $0
Preferred Stock INR 44,00,000
Common stock $0
60 shares @ INR 10000 per share (60% stake with Investor)
INR 6,00,000 -
40 shares @ INR 10,000 per shares(40% with Entrepreneur)
- INR 4,00,000
1,00,00,000/- INR 4,00,000/-
Deal Structure
• ROFR : Right of first refusal• Tag along rights : protection of minority share holder• Drag along rights :
– Drag Along : majority share holder Scenario (Protection to Majority)
– Drag along : minority share Scenario (Protection to Minority)
Protection Rights
• Management support or back seat driving• Later stage valuation issues• Management remuneration : too much or too less• Performance clause : too much equity???• Managing performance cycles• Exit points• Irrational exuberance
Conflict : Post Investment
Case Study: MMT
Make My Trip Financing Rounds• $1 million in the seed round (eVentures)• $10 million in Series A (SAIF partners)• $13 million in Series B (SAIF Partners,
Helion and Sierra)• MMT closed Series C investment of $15
million from Tiger Fund and the three existing venture capital investors – SAIF Partners, Helion Venture Partners and Sierra Ventures
• $70 million raised in IPO
Make My Trip OwnershipShareholder 2008 2009 2010 Post-IPO
Directors & Executive Officers 13.6%
SAIF 52.6% 51.5% 51.35% 43.8%
Tiger Global 5.6% 8.7% 12.09% 12.1%
Helion 12.1% 12.0% 11.98% 10.2%
Travogue 11.1% 10.1% 10.04% 8.8%
Sierra Ventures 8.1% 8.0% 7.98% 6.8%
