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Early-Stage Start-Up

Valuation Workshop

June
2015

By Jeff Faust, CVA


Director of Valuation Services

Objective of Presentation
Jeff Faust qualifications
FMV vs Investment Value
409A Overview
Overview of Valuation Methods
Sample valuation methods
Pre-revenue, pre-funding (FMV)
Pre-revenue, pre-funding (Investment Value)
Post-funding (FMV)
Profitable (FMV)

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

Jeff Faust Background


25 years in finance, serial entrepreneur.
20 years in Business Valuations.
Over 65 different industries.
All sizes and stages of development.
Employee Stock Ownership Plans (ESOPs), Stock Options (409A), Family Limited
Partnerships (FLPs), Buy-Sell Agreements, Estate/Gift Taxes, Mergers/Acquisitions
and Transactions, Litigation Support.
Testified in front of the Department of Labor and in several Superior Courts in the Bay
Area.
Certified Valuation Analyst (CVA) with the National Association of Certified Valuators
and Analysts (NACVA).
Instructor for the Venture Capital Academy (VCA).

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

Valuation Workshop
FMV vs Investment Value

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

Valuation Workshop
Overview of 409A
Deferred comp IRC Section
No discounted options (ISOs and NQSOs must be granted at FMV)
Options granted must follow 1 of 3 valuation methods

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

Valuation Methods
Is there one formula for valuation?

Income *
----------

Value

Risk

* Could be historical or projected but in all cases it is normalized

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

Valuation Methods
Most common
Income Approaches (DCF, DFE, Capitalized Earnings)
Market Approaches (Guideline, M&A and Comparable Transaction)
Asset Approaches (Book Value, Restated Net Worth)
Others used
Cost (Replacement)
Asset and Income Approaches (Excess Earnings)
Other / Start-Up Approaches (VC Method, Exit Multiples, Preferred
Rounds, Berkus Method, Scorecard Method, Cayenne Calculator,
People & Patents, Risk Factor Summation)
Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

Valuation Preparation (Know what Stage you are in!)


Stage of Development
1

Start-up

Enterprise has no product revenue and limited expense


history. Typically an incomplete management team has an
idea, plan, and possibly some initial product development.
Seed capital or first-round financing is usually provided by
friends and family, angels, or venture capital firms focusing on
early-stage enterprises. The securities issued to those
investors are occasionally in the form of common stock but are
more commonly in the form of preferred stock.

Development

Enterprise has no product revenue but substantive expense


history. Product development is underway and business
challenges are thought to be understood. Typically, a second
or third round of financing occurs during this stage. Investors
are usually venture capital firms which may provide additional
management or board of directors expertise. Securities
issued are typically in the form of preferred stock.

Alpha/Beta

Enterprise has made significant progress in product


development; key development milestones have been met
(e.g. hiring of the core management team); and product
development is near completion (e.g. alpha and beta testing
of the product, service, web site). Third party revenue is
beginning, although there may have been progress/milestone
payments from strategic business partners. Later rounds of
financing occur during this stage. Typical investors are venture
capital firms and strategic business partners. The typical
securities issued to those investors are in the form of
preferred stock.

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

Early Revenue

Enterprise has met additional key development milestones


(e.g. grow ing customer orders and revenue shipments). It
has a sufficient customer base to support ongoing operations,
but is still operating at a loss. A manufacturing and
distribution plan is being implemented Typically, mezzanine
rounds of financing occur during this stage. Discussions
frequently start with potential acquirers or investment banks
for an initial public offering (IPO).

Positive Cash
Flow

Enterprise has a history of product revenues, and has recently


achieved breakthrough measures of financial success, such as
operating profitability or positive cash flow s. Regulatory
approvals (e.g. Food and Drug Administration) have been
obtained. A liquidity event, such as an IPO or a sale of the
enterprise, could occur late this stage.

IPO

Enterprise has an established financial history of profitable


operations and generation of positive cash flow s. It is a
mature candidate for acquisition or an IPO. The form of
securities issued is typically all common stock, with any
outstanding preferred converting to common upon an IPO
(and perhaps also upon other liquidity events).

Valuation Preparation
(What discount range is appropriate)

Risk Discounts Ranges for Start-Ups


Scherlis and
Sahlman
Study (4)

Sahlman,
Stevenson
and Bhide
Study(5)

50% - 70%

50% - 70%

50% - 100%

40% - 60%

40% - 60%

40%-60%

Stage of
Development

Characteristics

Frei & Leleux


Life Sciences
Study (1)

Start-up

Pre-prototype

70% - 100%

60% - 80%

Early development

Pre-commercialization

50% - 70%

50% - 60%

First Stage

Commercialization

40% - 60%

40% - 50%

NA

NA

NA

Expansion

Shipping Product

35% - 50%

30% - 40%

35% - 50%

30% - 50%

30%-40%

Mezzanine/ IPO

Profitable

25% - 40%

25% - 30%

25% - 35%

20% - 35%

20%-30%

Seiffer
Software
Study (2)

Plummer
Study (3)

(1)

Frei, P. & Leleux, B. Valuating the Company. Starting a Business in the Life Sciences- from Idea to Market. (Luessen, H. (ed.).) 42-55 (Edition Cantor Verlag,
Aulendorf, Germany, 2003).
(2)

John Seiffer, "The Business of Software: The Venture Capital Rate of Return". < http://discuss.joelonsoftware.com/default.asp?biz.5.254929.9> (21 November
2005)
(3) Plummer, James L., QED Report on Venture Capital Financial Analysis, Palo Alto: QED Research, Inc., 1987
(4)

Scherlis, Daniel R. and Sahlman, William A., "A Method for Valuing High-Risk, Long Term, Investments: The Venture Capital Method," Harvard Business School
Teaching Note 9-288-006, Boston: Harvard Business School Publishing, 1989
(5) Sahlman, William A. and Howard H. Stevenson, Amar V. Bhide, Financing Entrepreneurial Ventures, Business Fundamental Series, Boston: Harvard Business
School publishing, 1998.

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

Sample Valuation Methods


Pre-Revenue, Pre-Funding (FMV)

Cost Approach
Est Repl Cost (low)

Est Repl Cost (high)

Current Expenses

$400,000

$400,000

Services In Lieu

$200,000

$400,000

Estimated Replacement Cost

$600,000

$800,000

Equity Value
Shares Issued
Stock Option Pool
Fully Diluted Shares

Price / Share

$600,000

$800,000

12,000,000
3,000,000
15,000,000

12,000,000
3,000,000
15,000,000

$0.040

$0.053
$0.05

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

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Sample Valuation Methods


Pre-Revenue, Pre-Funding (Investment Value)

Funding

Pre and Post Money Illustrations (value continuation)


A Round
Pre Money Valuation

B Round
$

Pre A Shares

4,000,000

Px/Share of Preferred A

0.27

Money Raised

1,000,000

Share Issued for A

3,750,000

Post A Shares
Post Money Valuation

Pre Money Valuation

15,000,000

20%

18,750,000
$

Pre B Shares
Px/Share of Preferred B **

0.27

Money Raised

1,250,000

Share Issued for B

4,687,500

Post B Shares

5,000,000

5,000,000
18,750,000

Post Money Valuation

20%

23,437,500
$

6,250,000

** Although the price per share is the same, the Post Money Valuation is clearly higher after the B Round

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

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Sample Valuation Methods


Pre-Revenue, Pre-Funding (Investment Value)

Funding

Pre and Post Money Illustrations (value increase)


A Round
Pre Money Valuation

B Round
$

Pre A Shares

4,000,000
15,000,000

Px/Share of Preferred A

0.27

Money Raised

1,000,000

Share Issued for A

3,750,000

Post A Shares
Post Money Valuation

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

Pre Money Valuation

18,750,000
$

5,000,000

$ 10,000,000

Pre B Shares

20%

18,750,000

Px/Share of Preferred B

0.53

Money Raised

2,500,000

Share Issued for B


Post B Shares
Post Money Valuation

4,687,500

20%

23,437,500
$ 12,500,000

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How do preferred terms impact value?


CVM The Effect of Different Capital Structures
Company 1
(No Preferred)

Company 2
(Non-Participating)

Company 3
(Full Participation)

Assumptions
Value
Common Shares Outstanding

$12,000,000

$12,000,000

$12,000,000

12,000,000

12,000,000

12,000,000

4,000,000

4,000,000

$12,000,000

$12,000,000

$12,000,000

$0

$4,000,000

$4,000,000

$12,000,000

$8,000,000

$8,000,000

12,000,000

12,000,000

16,000,000

$1.00

$0.67

$0.50

Preferred Shares Outstanding


(Assume Liquidation Preference is $1/share)

Share Calculation
Value
Less: Liquidation Preference
Equals: Remaining Amount
Divided by: Shares
Equals: Price Per Share

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

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Sample Valuation Methods


(Pre-)Revenue, (Pre-)Funding (Investment Value)

VC Method
Year 1
Revenue Projections
Which year will you be profitable?

What is your Peer Group Multiple?

Percent of Projections
Implied Future Valuation

Year 3

1,000,000

5,000,000

Year 4
20,000,000

Year 5
50,000,000

(Software = 2-3, SaaS = 4-6, Cloud = 5-8, Data = 8-12, Social = 10+)

50%
30,000,000

Enter discount rate (stage chart)


Estimated Funding Valuation

Year 2

90%
2,300,000

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Sample Valuation Methods


(Pre-)Revenue, (Pre-)Funding (Investment Value)

VC Method Multiples (Peer Group)


Market Value of Invested Capital (MVIC) as a Multiple of:
TTM
TTM
TTM
NFY
Revenue
EBITDA
EBIT
Revenue

Company Name
Abbott Laboratories
Baxter International Inc.
Mead Johnson Nutrition Company
Amicus Therapeutics, Inc.
Zalicus Inc.
Perrigo Co.

2.7
2.4
4.2
5.6
16.9
3.6

Maximum
Third Quartile
Average
Median
First Quartile
Minimum
Harmonic Mean
Coefficient of Variance
Selected Multiples

x
x
x
x
x
x

9.2 x
8.6 x
16.5 x
NM
NM
16.1 x

12.7 x
10.4 x
17.9 x
NM
NM
19.7 x

2.5 x
2.3 x
3.8 x
3.0 x
10.6 x
3.3 x

16.9 x
5.3 x
5.9 x
3.9 x
2.9 x
2.4 x
3.9 x
94%

16.5 x
16.2 x
12.6 x
12.7 x
9.1 x
8.6 x
11.5 x
34%

19.7 x
18.3 x
15.2 x
15.3 x
12.1 x
10.4 x
14.2 x
29%

10.6 x
3.7 x
4.3 x
3.2 x
2.7 x
2.3 x
3.3 x
74%

2.9 x

9.1 x

12.1 x

2.7 x

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Sample Valuation Methods


Early Stage (Investment Value)

Scorecard Method
Two-Step
(1) determine average pre-money of companies like yours
(2) compare target to perception of similar deals
Strength of Management Team

0-30%

Size of the Opportunity

0-25%

Product/Technology

0-15%

Competitive Environment

0-10%

Marketing/Sales Channels/Partnerships

0-10%

Need for Additional Investment

0-5%

Other

0-5%
-------100%

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

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Sample Valuation Methods


Early Stage (Investment Value)

Scorecard Method
Software Company
A company has an above average product and technology (125% of
norm), an average management team (100% of norm) and a large
market opportunity (150% of norm). The company can get to
positive cash flow with two rounds of angel investment (80% of
norm). Looking at the strength of competition in the market, the
target is average (100%) but early customer feedback on the product
is excellent (Other = 100%). The company needs some additional
work on building sales channels and partnerships (75%).

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Sample Valuation Methods


Early Stage (Investment Value)

Scorecard Method

COMPARISON
FACTOR
Strength of
Management Team
Size of Opportunity
Product/Technology

RANGE

TARGET
COMPANY

FACTOR

30%

100%

0.3000

25%

150%

0.3750

15%

125%

0.1875

Competitive
Environment
Marketing/Sales/
Partnerships
Need for Additional
Investment

10%

100%

0.1000

10%

75%

0.0750

5%

80%

0.0400

Other factors

5%

100%

0.0500

Sum: 1.1275
Assuming the average pre-money valuation is $2.7
million, we multiply that figure with the Sum of
Factors (1.1275 x $2.7 million). Therefore, we arrive
at a pre-money valuation of $3.04 million.

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Sample Valuation Methods


Early Stage (Investment Value)

Berkus Method
Developed by Dave Berkus of Tech Coast Angels
Characteristic

Add to Pre-money Valuation

Quality Management Team

0 - $500,000

Sound Idea

0 - $500,000

Working Prototype

0 - $500,000

Quality Board of Directors

0 - $500,000

Product Rollout or Sales

0 - $500,000

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

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Sample Valuation Methods


Early Stage (Investment Value)

Berkus Method
Characteristic

Add to Pre-money
Valuation

Target Company

Quality Management
Team

0 - $500,000

$375,000

Sound Idea

0 - $500,000

$425,000

Working Prototype

0 - $500,000

$500,000

0 - $500,000

$375,000

0 - $500,000

$375,000

0 - $2,500,000

$2,050,000

Quality Board of
Directors
Product Rollout or
Sales
TOTAL

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Sample Valuation Methods


Early Stage (Investment Value)

People and Patents


Each patent and engineers is ~$1M

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Sample Valuation Methods


Early Stage (Investment Value)

Risk Factor Summation


Series of Questions
Management, State of the business, Legislation/Political risk, Manufacturing risk,
Sales and marketing risk, Funding/capital risk, Competition risk, Technology risk,
Litigation risk, International risk, Reputation risk, Potential lucrative exit

+2 for very positive, +1 positive, 0 neutral, -1 negative, -2


very negative
For every +1 you add $250,000 (+$500k for +2) and subtract
$250,000 for every -1 (-$500k for a -2)

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Sample Valuation Methods


Early Stage (Investment Value)

Risk Factor Summation


Assume the average premoney valuation is $2.3 million,
and after tallying the points, the
sum is +1.
Therefore, you would add
$250,000 to the $2.3MM
average, bringing the
companys pre-money value to
$2.55 million.

Risk Factors

Risk Rating

Management

State of the Business

+1

Legislation/Political Risk

Manufacturing Risk

Sales and Marketing Risk

-1

Funding/Capital Risk

-1

Competition Risk

Technology Risk

+1

Litigation Risk

International Risk

Reputation Risk

Potential Lucrative Exit

+1

TOTAL

=+1

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Sample Valuation Methods


Any Stage (Investment Value)

Cayenne Calculator
www.caycon.com/valuation.php
Series of questions

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Sample Valuation Methods


Summary of Values
Method

Software

VC Method

$2.30 Million

Scorecard

$2.59 Million

Berkus

$2.05 Million

Cayenne

$1.84 $2.25 Million

Risk Factor

$2.55 Million

Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

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Sample Valuation Methods


Post-Funding (FMV)

Discounted Cash Flow (DCF) [exit multiples]


Projected Financials
FYE
12/31/12
Projected Earnings

FYE
12/31/13

FYE
12/31/14

FYE
12/31/15

(9.238) $

(5.235) $

1.528 $

6.859 $

1.00
0.624
(5.782) $

2.00
0.390
(2.042) $

3.00
0.244
0.373 $

4.00
0.152
1.045 $

Terminal
Year

FYE
12/31/16
10.537

Terminal Value Calculation

Revenue Multiple

12/31/16 $

165.526

2.7

Terminal Value
Present Value Period
Present Value Factor (3)
Present Value of Debt-free Cash Flow

60.0% Discount Rate

Sum of Present Value of Debt-free Cash Flow in Projection Period


Plus: Present Value of Terminal Value

(5.403)
32.406

Total Equity Value (Controlling, Marketable)

27.003

27.003

Less: Discount for Lack of Control


Total Equity Value (Non-controlling, Marketable)

0.0%

430.37

5.00
0.095
1.004 $

5.50
0.075
32.406

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Sample Valuation Methods


Profitable (FMV and Investment Value)

Discounted Future Earnings (DFE)


Projected Financials
FYE
12/31/12
Projected Earnings

FYE
12/31/13

FYE
12/31/14

FYE
12/31/15

1,454,100 $

1,537,125 $

1,703,328 $

1,885,410 $

1.00
0.813
1,181,525 $

2.00
0.661
1,015,436 $

3.00
0.537
914,822 $

4.00
0.437
823,264 $

Terminal
Year

FYE
12/31/16
2,181,030

Terminal Value Calculation


Gordon Growth Method

23.0% risk rate, 3.0% growth rate

Terminal Value
Present Value Period
Present Value Factor
Present Value of Net Income

23.0% Discount Rate

Sum of Present Value of Net Income in Projection Period


Plus: Present Value of Terminal Value
Indicated Equity Value
Less: Discount for Lack of Control
Total Equity Value (Non-Controlling, Marketable)

$
$
0.0%
$

11,232,307

5.00
0.355
774,265 $

5.00
0.355
3,987,467

4,709,312
3,987,467
8,696,779
8,696,779

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Great Website Resources


https://angel.co/
http://visual.ly/vizbox/startup-universe/
(search for Startup Universe)

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Q&A
Any questions?

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Contact Information
Jeff Faust, CVA
jfaust@aslcpa.com
(408) 377-8700 x232
Abbott Stringham & Lynch
1550 Leigh Avenue
San Jose, CA 95125
(408) 377-8700
Copy of presentation can be found here:
www.GoDead.com/valworkshop/earlystage2.pdf
(Password = earlystage2)
Copyright @ 2014 Abbott, Stringham & Lynch. All rights reserved.

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