VALUATION EXERCISE- BUILDING A CAP TABLE

1

Valuation Methods

Valuation Methodology

• There are numerous ways to value a company quantitatively and no one method is superior to all others

• Valuation is part science and part “gut”

• 3 categories: – Asset-based: rarely used now as mfg. shifts out of

the U.S.

– Cash flow capitalization, and

– Multiples, widely used for entrepreneurial co’s.

2

Multiples

• Cash flow multiples – EBITDA X (3 to 10)

– Adjusted up and down for contextual factors.

– May adjust EBITDA for founder salaries.

• Free cash flow multiples. – EBITDA – CAPEX

– Yields more conservative valuation

– Used when company requires major CAPEX to sustain growth

Multiples

• Sales multiples – Widely used, varies by industry

– Food industry = 1 to 2 X revenues

– Professional services = 1 to 3 X revenues

– Software companies = 2 to 3 X revenues

• P/E ratio method – For publicly traded companies

– Private companies can be based on “comps”

3

Free Cash Flow

• Most complicated and involved – AKA Discounted Cash Flow model

• Relies on many projections and assumptions

• Simply stated, projected future cash flows (generally 5 years), adjusted for taxes, depreciation, working capital and CAPEX, are discounted to PV using the weighted average cost of capital of the company PLUS residual value

Free Cash Flow Formula • Year 1 FCF/(1+DR)+Year 2 FCF/(1+DR)^2 +Year 3

FCF/(1+DR)^3 . . . + RV

• Many criticize model due to its complexity and uncertainties

• Bill Sutter (venture capitalist and Stanford Business School grad) says “I have not used any models since business school – valuation is remarkably unscientific”

4

Valuing Technology/Internet Companies

• Valuation methods discussed thus far are not applicable for valuing tech companies

• Early companies like Netscape, Yahoo, and Amazon.com all went public with little to no revenues at very high valuations

• Current models now focus on users and ultimate revenues attached thereto

• Ultimately, financial fundamentals count

Summary

• Many valuation methods, none of which is particularly better than others

• Valuation, particularly for early stage companies, is highly subjective

• Valuation is “educated speculation”

• Internet/tech companies don’t fit traditional models