Today I’ll finish my series on the Entrepreneur’s Guide To Venture Capital.
How To Valuate A Business
One of the most common questions I get around venture capital financing is how to determine the value of a business. Here is how we did it when I was in the business:
2013 Financial Projections
Earnings Before Tax $5,865,000
Tax Rate 42%
Taxes $2,463,300
Net Earnings $3,401,700
Amount Seeking to Raise Today $3,500,000
Discounted Value of Future Opportunity, 5 Years Out
2013 P/E Ratio 15
Value of Company in 2013 $51,025,500
Discount Rate Applied 30%
Year 2013 $51,025,500
Year 2012 $35,717,850
Year 2011 $25,002,495
Year 2010 $17,501,747
Year 2009 $12,251,223
Value of Company at Investment in 2004 $12,251,223
Less: Investment Amount $3,500,000
Present Value $8,751,223
Discount for Risk & Private Company 40%
Less: Discount for Risk & Private Company $3,500,489
Private Company Value $5,250,734
Present Value (What the Owner Keeps) $5,250,734 60.00%
Financing (What the Investor Gets) $3,500,000 40.00%
Total $8,750,734 100.00%
At the end of the day the venture capitalist will make an offer and you negotiate from there. This model is far from perfect but does give you a starting point to valuate your business.
Featured on:
[...] [...]
Your example is one good approach, but in my experience in the investor community, I found several additional techniques and rules of thumb which are useful in early stage valuations. I recently published an article on my website summarizing these, called “Ten Top Techniques for Startup Valuation”.
If interested, you can see the whole article on http://www.startupprofessionals.com, but here are the ten bullets:
1. Place a fair market value on all physical assets (asset approach)
2. Assign real value to intellectual property
3. All principals and employees add value
4. Early customers and contracts in progress add value
5. Use discounted cash flow (DCF) on revenue projections (your example)
6. Multiple of discretionary earnings (earnings multiple approach)
7. Calculate replacement cost for key assets (cost approach)
8. Find “comparables” who have received financing (market approach)
9. Look at the size of the market, and the growth projections for your sector
10. Assess the number of direct competitors and barriers to entry
In summary, there is both art and science to startup valuations, so the more you know, the more you can maximize your valuation.
Marty Zwilling
CEO, Startup Professionals, Inc.
Nice post – and excellent response from Marty. Thanks for your contributions.
Just finished with the whole series here. Great stuff! (Even though I need to do some accounting homework before I can fully digest the valuation above.)
Thanks for bringing all the links together under one post.