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Valuation Methods: Discounted Cash Flows
Venture capital firms will often employ a derivative of the discounted cash flows method to value the company. The approach estimates the earnings of the company at a point in the future where an exit is anticipated and then, using the price-to-earnings (P/E) ratio of comparable companies, determines the value of the company at that future point. Then, using a discount rate, the value of the company today is determined. Here are the steps to this valuation approach:
1. Using the financial information provided to the potential investor, estimate the company’s net income at the point in the future where the investor will exit the investment.
2. Looking at comparable companies with similar economic characteristics, determine an appropriate P/E ratio.
3. Multiply the P/E ratio with the net income value to determine the value of the company at the expected liquidity event.
4. Discount this future value to the present, generally using a rate from 30 to 40 percent (but up to 80%)
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Valuation Methods: Comparable Valuations.
Comparison data about similarly-situated companies can provide valuable information on appropriate valuations. While the amount of funding for comparison companies is readily available on a variety of websites including CapitalHunter.com, GrowThinkResearch.com, LocalBusiness.com, and CapitalGrowth.com, it is more difficult to obtain accurate valuation information. Your attorney may also have information on specific-industry deal points, including average valuation terms.
Some companies are now providing more specific information such as pre-money valuations. The Private Equity Data Center (pedatacenter.com) offers valuation information on companies for $49.95 per company. VentureOne provides a “Comparable Valuations Report” analyzing comparable business fundraisings and valuations for $1,295.00.
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Valuation Methods: Comparable Exit Events
Another approach that may provide another data point in determining the appropriateness of a valuation figure is looking at exit events of comparable companies. To find comparable companies that have recent merger and acquisition activity, you can look in industry trade press or review local news sources. The Private Equity Hub (PEHub.com) provides news on exit events for venture-funded companies and has feature to search past news stories.
Thomson, in its database Venture Economics (vx.thomsonib.com), offers a paid subscription service tracking venture-funded merger and acquisition activity.
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Valuation Calculator
You’ve heard that coming up with a company valuation is an art. So how then can you tell if the valuation you receive is even reasonable?
Cayenne Consulting provides a free valuation calculator tool (www.caycon.com/valuation.php) to assist entrepreneurs and investors with the difficult process of determining an approximate range. Based on your responses to 25 questions (each questions has four potential responses), the tool will provide you a valuation ranging from $0.5 million up to more than $40 million.
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