Venture Capital Valuation

Poseidon Robotics

In this exercise, you will perform a valuation of Poseidon using a mixture of ad hoc VC empirical valuation
methods, along with the standard PE exit driven valuation.

Poseidon was founded in Poland in 2015 by a group of friends from university. The founder, Ivan, studied
engineering and robotics and his co-founders, Boris and Macej, studied also robotics and computer
science respectively. All three got their PhDs during their time developing Poseidon.

The product is an underwater robot which is guided by a long cable. The original model was about 70cm
long and was equipped with camera, sensors and robotic arms. Later models for industrial use also had
light welding equipment and other features, which could be customised according to needs. The really
innovative feature of the robot was that it could be manufactured with 3D printing, which hugely
lowered its production costs. It could be controlled either with a portable drone type console or by a
central control room.

The original robot was conceived as a product for the consumer market, for people to play with on the
beach or as an accessory for scuba and aqualung divers. There was interest but the possibilities were
somewhat limited. Through a process of trial and error, the Founders realised that there was potentially
great interest from companies conducting underwater maintenance at sea, such as on oil rigs, offshore
wind farms, undersea cables, ships and other plant which was submerged or partially submerged at sea.
The robot was useful in situations where divers would be exposed to too many risks or where the cost
of professional specialised divers was too high.

They also realised that because of the complex technology and this being a relatively small line item, it
was very unlikely any industrial maintenance company would ever bother developing this product in-
house. On the other hand, they may be potential acquirors of the business if it achieved a critical mass
of sales of over €100m.

The initial prototypes were built in a garage in 2016 and it was only in 2019 that non-experimental,
robust and tested prototypes of different kinds of robots were really trialled seriously, leading to
Poseidon generating its first sales revenue in 2019.

The Founders adapted a large shed in the farm of Ivan’s father’s farm and built from scratch a
rudimentary but effective production facility. By 2019 all three Founders had gone full time into the
venture and had invested a total of €300K of their and their parents’ money. The use of the shed was
for free. By the end of 2019, apart from the three of them, they had hired nine other people. These
people were sold on the idea of Poseidon so accepted very reduced salaries and stock options. Two of
the staff had PhDs in robotics and worked on product development, two engineers worked in
manufacturing and there were two full time sales people plus one external collaborator. The other three
were a general maintenance engineer, a secretary/receptionist/PA and a administrator/bookkeeper.

The company was owned 45% by Ivan, 20% Boris, 15% Macej and the remaining 20% (non voting) was
reserved for the staff. The Board of Directors of the Company consisted of Ivan and his father, Boris and
Macej. Macej’s father had founded a successful packaging machinery business thirty years previously,
which employed 250 people.
The robots were initially developed by the Founders alone, Following their decision to develop industrial
robots, they formed partnerships with three local companies in 2018, who helped them develop their
products and provided some advance funding. The robots were patented by the Company, starting in
2017.

In 2020 the Company started to take real shape as an organised entity, with some conversions made to
the shed into an organised manufacturing facility and offices. Apart from Ivan’s father, the Founders,
who were by then in their mid twenties, were assisted by Mario, an experienced retired executive from
Italy who had a long track record in industrial maintenance and whose services were funded by a Polish
government entrepreneur technical assistance programme.

In discussions with Mario, The Founders realised that in order to take their company forwards and really
scale up, they would have to seek venture capital finance. Mario helped them to develop a robust and
detailed business plan, on which they worked thoroughly, including having inputs from their historic
clients, suppliers and a local venture capitalist friend of theirs from university days (whose fund only did
medical sector, so could not invest in them). They also hired a local lawyer with good knowledge of VC
and patent law, upon their VC friend’s recommendation.

By the end of 2020, the Founders were ready to negotiate with VCs for a potential investment. Their
plan called for an investment of €10m, which would be used for investments in machinery and working
capital. Following that, they estimated that they would be able to fund further capital requirements
over the next five years with long term, debt, including a special entrepreneur loan guarantee program
from the European Investment bank and other EU financial institutions.

Looking at the financials, the total investment made by the founders since inception was as follows:

Poseidon Robotics ('000€) Accumulated costs at end Year 1

Founder capital injected 150
Co-founders capital injected 150
Founder time (2400 hours X $500/day) 150
Co-founders time (3600 hours X $330/day) 135
Estimated goodwill of a patent 100

Total 685

The plan developed by the Founders is as follows:

Poseidon Robotics (€m) Year

2020 2021 2022 2023 2024 2025
Sales 3 8 20 40 70 100
EBITDA 0 0.4 2 6 10.5 20
Net Debt 10 30 50
Equity Injection 10

In preliminary discussions with some VCs and with the help of their VC friend, the Founders estimated
that the company, if it achieved a critical mass of sale over €50m, would be valued based upon an
EV/EBITDA multiple of 5 times. They also saw that VCs used a 35% hurdle rate to value an early stage
company such as Poseidon.
You are one of the VCs who has had an initial meeting with the Founders.

Your task is to estimate the pre money valuation of Poseidon, at the end of 2020.

You should use all the following methods:

-Exit driven method

-Berkus method

-Risk factor summation method

-Scorecard method

-the online Cayenne calculator. You can fund this at https://www.caycon.com/valuation

The other methods, see the Appendices.

Following the exercise, you will share your results.

Relevant questions for discussion:

What are the methods equivalent to?

Which is the most credible method?

How important is the valuation? How to balance this with the need to keep Founders motivated with
sufficient equity?
 Appendix 1

Berkus Method

Dave Berkus is a founding member of the Tech Coast Angels in Southern California, a lecturer and
educator. He has invested in more than 70 startup ventures. Dave’s valuation model first appeared in
a book published by Harvard’s Howard Stevenson in the middle nineties. It has been used by angels
since.

Characteristic Add to Pre-money Valuation

Quality Management Team Zero to $0.5 million

Sound Idea Zero to $0.5 million

Working Prototype Zero to $0.5 million

Quality Board of Directors Zero to $0.5 million

Product Rollout or Sales Zero to $0.5 million

Note that the numbers are the maximum for each class (not absolutes) so a valuation can be $800K (or
less) as easily as $2.5 million.

One can make several comments on the Berkus Method:

This is a useful method and should be in an investor’s valuation toolbox.

It is good to establish some triggers for fundable companies. For example, some investors would not
fund a company without at least a minimum of customer feedback or intellectual property. It is always
a good idea for VCs to establish the minimum expectations for fundable companies.

Some issues or characteristics may be missing from Dave’s methodology.

Is the competitive environment important in the business sector of the target venture? If so, perhaps
consideration of such value should be considered.

Is the depth of intellectual property and competitive differentiation important to the target venture? If
so, perhaps consideration of such value should be considered.

Is the size of the opportunity to investors considering funding this target company? If so, perhaps
consideration of such value should be considered.

However, referring to above, it is possible for investors to consider each of these above three
characteristics as minimum triggers for investment.

One last comment that can be made, is that this method is more widely used in “developed” VC markets,
such as the US West Coast. In Europe, the values may need to be scaled down.
 Appendix 2

Risk Factor Summation Method

The Risk Factor Summation Method, described by the Ohio TechAngels, considers a much broader set
of factors in determining the pre-money valuation of pre-revenue companies. This method may be less
useful as a stand-alone valuation method for investors, but could be one of several methods used by
early stage investors to establish pre-money valuation, because it forces investors to consider important
exogenous factors.

The Ohio TechAngels describe the method, as follows: ”Reflecting the premise that the higher the
number of risk factors, then the higher the overall risk, this method forces investors to think about the
various types of risks which a particular venture must manage in order to achieve a lucrative exit. Of
course, the largest is always ‘Management Risk’ which demands the most consideration and investors
feel is the most overarching risk in any venture. While this method certainly considers the level of
management risk it also prompts the user to assess other risk types,” including:

Management

Stage of the business

Legislation/Political risk

Manufacturing risk

Sales and marketing risk

Funding/capital raising risk

Competition risk

Technology risk

Litigation risk

International risk

Reputation risk

Potential lucrative exit

Each risk (above) is assessed, as follow:

+2 very positive for growing the company and executing a good exit

+1 positive

0 neutral

-1 negative for growing the company and executing an exit

-2 very negative

The average pre-money valuation of pre-revenue companies is then adjusted positively by $250,000 for
every +1 (+$500K for a +2) and negatively by $250,000 for every -1 (-$500K for a -2).

As an example, Assume the average pre-money valuation of pre-revenue companies is $1.5 million. If
your judgment of the twelve factors above has five neutral assessments (five zeros), five +1’s, one -1 and
one -2 (a net of two +1’s), then add $500,000 to the average valuation of $1.5 million, arriving at a $2
million pre-money valuation.
 Appendix 3

SCORECARD VALUATION METHODOLOGY

Establishing the Valuation of Pre-revenue, Start-up Companies
by Bill Payne

Background
Individual accredited investors in typical angel deals put personal capital at risk for an equity
share of growth-oriented, start-up companies. These angel investors generally invest $25,000
to $100,000 in a round totaling $250,000 to
$1,000,000. In 2011, the valuation of pre-revenue, start-up companies is typically in the range
of $1–$2 million and is established by negotiations between the entrepreneur and the angel
investors. For this round of investment, the angels collectively purchase 20-40% of the equity of
the company and are seeking a return on investment of 20-30X in a period of five to eight years.

Active angels invest in a diversified portfolio of 10 or more companies, usually spreading their
investments over a few years. Experience proves that half of these companies will fail (returning
nothing or less than capital invested), another 3-4 will provide a modest return on investment
of 1X to 5X and one or hopefully two of the ten companies will return 10X to 30X on the initial
investment over a five to eight year period of time. In the end, such a portfolio might yield the
angel investor a total return on investment of 25% per year or more.

Angels typically invest in companies operating in industry sectors with which they are familiar.
Diversification across industry sectors is not as easily achieved for angels as could be
accomplished in public markets, but can be achieved by co- investing with trusted angel
colleagues in a broader set of businesses. A local network of angels is critical to achieving a
diversified portfolio. Working within a network of angel investors also expands the pool of
expert resources and helps divide the work of screening companies and investment due
diligence.
Furthermore, angel groups frequently syndicate (co-invest) with neighboring angel
organizations in an effort to help fill round of investment for local companies and assist
members in diversifying their portfolios with investments in nearby regions.

To achieve a satisfactory return on investment, the angel’s portfolio must contain one or two
companies which return 20–30X on the initial investment. It is, of course, impossible to predict
at the outset which of these portfolio companies will be successful and which will fail. It is
necessary, then, that each investment in the angel portfolio demonstrates the potential to scale
sufficiently to provide a 20-
30X return on investment. Including a substantial number of investments with smaller
opportunities only reduces the possible return on the entire portfolio.

Scorecard Valuation Methodology

This method compares the target company to typical angel-funded startup ventures and
adjusts the average valuation of recently funded companies in the region to establish a pre-
money valuation of the target. Such comparisons can only
be made for companies at the same stage of development, in this case, for pre-revenue
startup ventures.

The first step in using the Scorecard Method is to determine the average pre- money valuation
of pre-revenue companies in the region and business sector of the target company. Pre-money
valuation varies with the economy and with the competitive environment for startup ventures
within a region. In most regions, the pre-money valuation does not vary significantly from one
business sector to another. The following is an informal survey of angel groups taken by the
author in the summer of 2010 for pre-revenue companies in several regions of North America:

2010 Angel Valuation Survey

(Pre-money Valuation of Pre-revenue Companies)

Pre-money
Angel Group Valuation*
Tech Coast Angels $1.25
Phenomenelle Angels $1.30
New York Angels $1.30
Frontier Angel Fund $1.40
DC Dinner Clubs $1.50
Vancouver Angel Network $1.50
Midwest Groups (Okabe) $1.50
RAIN Funds $1.65
Ohio TechAngels $1.75
Band of Angels $1.75
Life Science Angels $2.00
Alliance of Angels $2.10
CommonAngels $2.70
mean $1.67
mode $1.50
* in Millions
of Dollars

As can be seen the average pre-money valuation for recent pre-revenue deals is
$1.67 million but the mode (middle number) is $1.5 million, indicating some skewed data at
the upper range of the data set. It appears that competition for deals in some regions of the
country results in higher valuations there. The range of the data is from a low pre-money
valuation of $1.25 million to a high of
$2.7 million for pre-revenue companies.

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We also have data points for VC investments in seed/startup companies (but not necessarily
pre-revenue companies). The following chart from Dow Jones VentureSource shows very little
variation in pre-money valuation of VC seed stage deals over the past decade. Average annual
pre-money valuations have been just over $2 million during this period. Since VCs typically
invest a bit later than do angels, we would expect VC seed valuations to be slightly higher than
those of angels.
First Round Median Valuation Rises in 1H ’09 vs. 2008

Median Premoney Valuations by Round Class (Annual)

$89.6
$90
Median Premoney Valuation ($M)

$60 $36.5 $40.0 $34.0

$19.7
$13.8

$7.3
$30 $6.7

$0

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 1H09

Later Stage Second Round First Round Seed Round

Source: Dow Jones VentureSource

For purposes of this study, we will assume that the pre-money valuation of pre- revenue
companies varies in the range of $1-2 million and that the average pre- money valuation for
these firms is $1.5 million.

The next step in determining the pre-money valuation of pre-revenue companies using the
Scorecard Method is to compare the target company to your perception of similar deals done in
your region, considering the following factors:

Strength of the Management Team 0-30%

Size of the Opportunity 0-25%
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Product/Technology 0-15%
Competitive Environment 0-10%
Marketing/Sales Channels/Partnerships 0-10%
Need for Additional Investment 0 - 5%
Other 0 - 5%

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The subjective ranking of factors (above) is typical for investor appraisal of startup ventures.
Some are surprised to find that investor rankings of product and technology are below those
of the management team and the size of the opportunity. In building a business, the quality
of the team is paramount to success. A great team will fix early product flaws, but the reverse
is not true. And, as has been discussed earlier, scalability is critical to investor returns.
Good product and intellectual property are important, but the quality of the team is key.

Making the Valuation Calculation

To provide an example, assume a company with an average product and technology (100% of
norm), a strong team (125% of norm) and a large market opportunity (150% of norm). The
company can get to positive cash flow with a single angel round of investment (100% of norm).
Looking at the strength of the competition in the market, the target is weaker (75% of norm)
but early customer feedback on the product is excellent (Other = 100%). The company needs
some additional work on building sales channels and partnerships (80% of norm).
Using this data, we can complete the following calculation:

COMPARISON FACTOR RANGE TARGET FACTOR

COMPANY
Strength of Entrepreneur and Team 30% max 125% 0.3750
Size of the Opportunity 25% max 150% 0.3750
Product/Technology 15% max 100% 0.1500
Competitive Environment 10% max 75% 0.0750
Marketing/Sales/Partnerships 10% max 80% 0.0800
Need for Additional Investment 5% max 100% 0.0500
Other factors (great early customer feedback) 5% max 100% 0.0500
Sum 1.0750

Multiplying the Sum of Factors (1.075) times the average pre-money valuation of
$1.5 million; we arrive at a pre-money valuation for the target company of about
$1.6 million (rounding from the calculated $1.61 million).

Summary
Key to the Scorecard Method is a good understanding of the average (and range) of pre-money
valuation of pre-revenue companies in a region. With this data in hand, the Scorecard Method
gives angels subjective techniques to adjust the valuation of a target company for seed and
startup rounds of investment.
Savvy entrepreneurs can use these tools to prepare for negotiations of valuation with
investors.

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6
 Factors and Issues

IMPACT ON THE VALUATION OF STARTUP COMPANIES

Weight

0-30% Strength of the Entrepreneur and the Management Team

Impact Experience

+ Many years of business experience

++ Experience in this business sector

+++ Experience as a CEO

++ Experience as a COO, CFO, CTO

+ Experience as a product manager

- Experience in sales or technology

--- No business experience

Impact Willing to step aside, if necessary, for an experienced

CEO

--- Unwilling

0 neutral

+++ Willing

Impact Is the founder coachable?

+++ yes

--- No

Impact How complete is the management team?

- Entrepreneur only

0 One competent player in place

+ Team identified and on the sidelines

+++ Competent team in place

0-25% Size of the Opportunity

Impact Size of the target market (total sales)

-- < $50 million

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 + $100 million

++ > $100 million

Impact Potential for revenues of target company in five years

-- < $20 million

++ $20 to $50 million

- > $100 million (will require significant additional funding)

0-15% Strength of the Product and Intellectual Property

Impact Is the product defined and developed?

--- Not well define, still looking a prototypes

0 Well defined, prototype looks interesting

++ Good feedback from potential customers

+++ Orders or early sales from customers

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 Impact Is the product compelling to customers?
--- This product is a vitamin pill
++ This product is a pain killer
+++ This product is a pain killer with no side
effects
Impact Can this product be duplicated by the
others?
--- Easily copied, no intellectual property
0 Duplication difficult
++ Product unique and protected by trade
secrets
+++ Solid patent protections
0-10% Competitive Environment
Impact Strength of competitors in this
marketplace
-- Dominated by a single large player
- Dominated by several players
++ Fractured, many small players
Impact Strength of competitive products
-- Competitive products are excellent
+++ Competitive products are weak
0-10% Marketing/Sales/Partners
Impact Sales channels, sales and marketing
partners
--- Haven't even discussed sales channels
++ Key beta testers identified and contacted
+++ Channels secure, customers placed trial
orders
-- No partners identified
++ Key partners in place
0-5% Need for additional rounds of funding
+++ None
0 Another angel round
-- Need venture capital
0-5% Other
++ Positive other factors
-- Negative other factors