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Start up Valuation

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A Venture Capital Case

 ” Vulture Ventures” fund has to finance “ABC” , a start-up firm and
needs to decide the number of shares he should demand for his investment
and its price.
 The founders of ABC expect to sell the company for $25 million in 4 years
( Industry P-E ratio 10 , Projected income $2.5 million)
 At this point the company wants to raise $3 million
 The private equity player demand a discount of 50% to compensate for the
risks involved.
 The owners decide to retain 1 million shares.
 Defining Variables
 V=terminal value = 2.5*10= $25 million (in 4 years)
 t=time to exit =4 years
 I= amount of investment =$ 3 million
 r = Discount rate used by investors=50%
 x= no of existing shares = 1 million

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Demonstrating the VC Method

 Step 1: Determine the post-money valuation
Only positive cash flow occurs at the time of exit
POST=V/ (1+ r) t = $ 25 m/ (1+50%) 4 = $ 4,938,272
This is the current value associated with the firm after receiving required
$ 3 mm investment

 Step 2: Determination of pre-money valuation

This is the post-money valuation minus the cost of investment.
PRE=$ 4,938,272 - $3 million= $ 1,938,272

 Step 3: Determination of ownership fraction , F

Equivalent ownership of the investment made by Vulture Capital’s i.e.
Required Percentage Ownership=Investment/ POST
F =$3 million/$ 4,938,272 = 60.75%
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VC Method Contd..
 Step 4: Obtaining the new number of shares
The owners want to hold 1million shares . To achieve the desired
60.75% ownership the VC player needs to obtain the new number of
shares.
Number of shares= x [F/ (1-F)] = 1 million
[0.6075/ (1-0.6075)] = 1,547,771

 Step 5: Obtaining the share prices

Price per new share=Investment/ new number of shares=$3 mn/
1,547,771= 1.94

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Sensitivity Analysis
 Reduce the terminal value by 10%
 Increase IRR by 10%
 Increase Investment by 10%
 Increase time to exit by 10%
 Increase the number of existing shares –no effect

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Results of the Analysis

Increase in investor's ownership or

Decrease in Owner’s wealth

(+100%)Existing shares

(+10%)Time

(+10%) Investment

(+10%)IRR

(-10%)Terminal Value

0% 10% 20% 30% 40% 50% 60%

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Venture Capital Valuation Method - Multiple Rounds

of Financing

 Suppose ABC has a zero cash balance, the $ 3

million investment it got from Vulture Ventures
would suffice only for two years and further $ 2
billion money will be needed in two years time
 This would result in dilution of ownership of
existing investors, thus the valuation method in
this case should consider the dilution effect on
the equity of 1st round of investors