1. Class 9 Notes
Valuation
© Andrew W. Hannah

2. Agenda Midterm Grades Homework due tonight Reflecting… Recommendations
Winning Angels - valuation
ContentSoft recommendation
Reflecting…
Recommendations
Valuation
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3. Reflecting… What investors do – raise, invest, harvest Angels vs. VC’s
History and trends
Fund economics
Investment models
Deal sourcing and screening (filters)
Deal evaluation (the entrepreneur and the pitch)
Due diligence
Deal Structure
Valuation
Contracts and terms
© Andrew W. Hannah

4. Investment Recommendations
Goals
Present a clear picture of the company, product and opportunity
Present the diligence results in a manner that supports the recommendation
Basis for the recommendation
Markets – size, growth rate, key features
Competition – direct and indirect, key features, strength and weaknesses
Comparables – business model, financials, valuation
Valuation – how much? Exit and when?
© William Hulley and Andrew W. Hannah

5. Investment Recommendations (Cont.)
What is included in the company’s plan?
The Overview – a presentation of the company’s plan
Market
Customer
Product
Management
Competition
Competitive Advantages
Financial Overview
The Diligence
Comparables
Valuation
Recommendation – yes or no and why
The diligence memos (as appendices)
ContentSoft Example
© William Hulley

6. Valuation
© Andrew W. Hannah

7. Why Are Companies Worth What They Are Worth?
ICGE, Ariba, Cisco
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8. The Fundamentals of a Stock Price
Share Price= Company Valuation / # of shares
Company Valuation = Share Price * # of shares
Share price is what we follow but what is really fluctuating is valuation
© Andrew W. Hannah

9. So What Is Valuation Anyway?
Theory versus practice
Theory : Discounted Cash Flows
Discounted = Net Present Value
Cash Flows = Expected cash inflows less expected cash outflows
Inflows = Cash from customers
Outflows = Costs to run the company
© Andrew W. Hannah

10. Present Value Basics Future Value You have $1
I guarantee you 10% interest for three years (or inflation is at 10%)
Your value:
Year 1: $1.10
Year 2: $1.21
Year 3: $1.33
You are indifferent!
$1.33 in three years
$1.00 today
© Andrew W. Hannah

11. Simple NPV What is the NPV? Discount Rate = 10% Time = three years
So….
Discount Rate = 10%
Time = three years
Future Value = 1.33
What is the NPV?
© Andrew W. Hannah

12. Back to Valuation…
Valuation (NPV) = Discount Cash Flows over some period of time
Discount Rate = 100% (cost of capital)
Year
FCF $10 $20 $30
PV Fctr
PV $10 $10 $7
NPV $ vs. $27
© Andrew W. Hannah

13. The Real Calculation + DCF year ‘n’ / (cost of capital – growth rate)
NPV = Discounted Cash Flows (DCF)
+ DCF year ‘n’ / (cost of capital – growth rate)
Terminal Value = the new part
Discount rate = cost of capital
Rate you could borrow/obtain money at to grow your business
Lower the risk the lower the cost of capital
Low risk = Bank debt (8% or Prime + x%)
Higher Risk = Public Offering (20%)
Highest Risk = Venture capital (50%? 75%? Higher)
Growth rate = expected annual increase in cash flows
© Andrew W. Hannah

14. NPV Formula – Cleaned Up
NPV = Future Value/ (1 + d) ^t
Future Value = cash flow
d = discount rate
Reflects cost of capital
Risk free rate + risk factor
t = time (“years”)
Terminal Value: cash flows in perpetuity = [FCF (year n)/ (d – g)]/ (1 + d) ^ n
g = growth rate of FCF in perpetuity
© Andrew W. Hannah

15. Valuation Example Discount Rate = 10% Growth Rate = 4%
Year TV
FCF $10 $20 $ $30
PV Fctr
PV $10 $ $ $413.22
NPV $466.19
TV= [$30/(10% - 4%)]/ 1.21 = $413.22
(Revisit ICGE and CSCO)
© Andrew W. Hannah

16. In the End.. Are cash flow projections realistic Growth rates
Valuation is based on expectations:
Are cash flow projections realistic
Growth rates
Risk of execution (discount rate)
Sustainable position
Ability to innovate
© Andrew W. Hannah

17. Valuation Methods For Entrepreneurial Companies
Discounted cash flow?
Multiples of public companies and sale of private companies:
Sales
Earnings (current/future)
Customers?
Negotiation
Remember: discount rates = risk and required rate of return = cost of capital
© Andrew W. Hannah

18. Valuation Methods By Stage
Use of Proceeds
Pre-Money Determinant
Key MV Drivers
“Plan in Hand”
Proto-type Research
Formulaic ($2 - $6 M)
Founder Experience
Post-Seed (“A”)
Proof of concept
Negotiation ($8 - $15)
Tangibles/ Intangibles
Early Growth (“B”)
Mgmt Team
Customers
Negotiation ($15 - $30M)
High Growth (“C”, “D”)
Expansion
Acquisition?
Comp Driven ($45 - $55M)
Public/Private Transactions
© Andrew W. Hannah

19. What Makes a Difference?
The team’s experience
Stage of development
Customers
Protectable IP
Economic conditions
Size of the opportunity
Other
© Andrew W. Hannah

20. Valuation Strategy
Entrepreneurs must triangulate (dcf and public & private multiples)
VC’s:
Discount projections
Look for 55% discount factor
Look hard at public and private multiples
Entrepreneurs best strategy: create an auction
© Andrew W. Hannah

21. Pre- and Post-Money Valuation
Pre-money valuation = value of the company before the investment round
Post-money valuation = value of the company after the investment round
Example
You own 50% of a company
Pre-money valuation = $10 million
You are raising $5 million
What is the post-money valuation?
What is your new ownership percentage?
© Andrew W. Hannah

22. Next Week Contracts and Control Diligence Card “B” – comparables
WA: 179 – 222 (this is different than the syllabus)
© Andrew W. Hannah