Depending on who you ask, there are a number of ways to value your startup. I will however categorise them into 2 broad segments: “Intrinsic Valuation” and “Relative Valuation”.
The intrinsic valuation tends to value the startup solely based on the perception of its true value. This perception is usually based on the startup’s financial performance and potentials. Most times, the intrinsic valuation is based on the free cashflow of the business. It is calculated as the net present value of the future cashflow of the business. I will however not get into the details of this because it is mostly not applicable for early stage businesses. This is because you are required to project the future cashflows of the business based on its historical performance and future strategy. However, since we do not have sufficient historical context, justifying the forecast will be extremely difficult.
This method is best suited for more mature companies.
The relative valuation on the other hand is an attempt to value the business based on the valuation of a comparable business. This is less technical and more applicable to most startups.
Let me explain this in a really basic term. Imagine you want to value PrepClass, for instance. Relative valuation suggests that the valuation multiple of PrepClass will be similar to that of Tuteria or other Edtech businesses operating with a similar model in Nigeria.
When identifying the comparable company, you need to find businesses operating in similar markets –say emerging markets. Then you find businesses at a similar stage as your startup. You will be comparing apples with agbalumo if you compare the valuation multiple of PayPal with Paystack; the markets are different, so also are the stages of both businesses.
I believe that the most difficult part of relative valuation is identifying the comparable companies as well as finding the applicable multiple. This is difficult because most private companies do not disclose their valuation information publicly.
Due to the difficulty in finding a perfect comparable in a market like ours, POOTA is important (I explained POOTA in my previous post). In a situation where you are confined to using a semi-perfect comparable, there are adjustments that can be made to reflect the stage or the market of the target startup. It is also best practice to use more than 3 comparable companies and weed out outliers. This will give a more robust valuation picture.
There are 2 major valuation methods that we will discuss – “Precedent Transaction Method” and “Comparable Trading Multiple”.
The precedent transaction method suggests that the price paid for similar companies in the past is considered an indicator of a company’s value. While comparable trading multiple is similar to the precedent, but here, the comparable companies are trading in the public market. Like you must have suspected, we won’t be able to use the comparable trading multiple because of the stage of our startups.
I will explain this in practical terms using a hypothetical scenario. Our hypothetical startup is “booknow.ng” an online travel agent operating in Nigeria. BookNow is looking to raise $4.5m in Series A capital to expand to (you know the usual suspects) Ghana and Kenya after starting operations 3 years ago. So, we will use the relative valuation method to value the business.
Traditionally, an E-commerce business is valued based on its GMV – Gross Merchandise Volume. This refers to the total volume (USD being the currency of measure) of sales over a given period (Say 1 year).
To explain this, imagine you booked a hotel on BookNow.ng for a night at N50k. The N50k represents BookNow’s GMV. BookNow can then charge the hotel 10% of the transaction value – N5k. The N5k is then the net revenue for BookNow.
Getting into it, imagine that BookNow generated a total GMV of $20m in FY (full year) 2017. In determining the valuation, we will look for comparable companies operating as online travel agents. An online hotel booking platform should not be considered as a comparable. This is because the online travel agent’s GMV can be skewed based on the addition of airline bookings, which is typically more than hotel room bookings. These comparable companies should also be operating in similar markets. See below the list of hypothetical comparable companies:
Now that we have our comparable (comps) companies, we will then apply our multiple to the GMV of our target company – BookNow. There are a few tricks you can use here to get a higher valuation, but those are discussions for another time. Just to drop a hint, you can manipulate your comps by excluding the low multiple comps and leaving only the ones with higher multiples.
For this analysis, I will be using the median value. The average value will not be used because it has been skewed by the outliers – SafariTrip especially. So, the median actually represents the true picture of the comps.
|BookNow Valuation Analysis|
Then you apply your selected multiple on the GMV of your startup to get your ideal valuation number. This number can then be sensitized, but leave that to financial analysts to figure out. The idea about sensitivity is to understand how any change in certain variables (Multiple, GMV) would affect your valuation number.
The other thing to understand is the dilution impacts. Now that we have got our ideal valuation number, this suggests that it is the valuation of the company before any capital injection (pre-money). But don’t forget that BookNow is raising $4.5m. What we are trying to get is how much stake the new investors will get at this $24.3m valuation.
|BookNow Dilution Analysis|
This implies that new investors will get 15.6% stake in the business, while existing investors will maintain 84.4% stake in the business.
Cap table, as we like to call it, provides an analysis of a company’s percentage ownership, equity dilution and value of equity in each round of investment by founders, investors and other shareholders. Also, note that BookNow raised a previous seed round of $1.5m before the current Series A round. It also has 2 co-founders who work as the CEO and CTO.
3 investors participated in the previous Seed Round, while 2 investors participated in the current round. The seed round was concluded at a $7m pre-money valuation. So the cap table will capture the shareholding of the business since inception till date.
The table shows the dilution impact of each capital raising round on the existing shareholders. Though the founders’ stake has been diluted from 45% each at pre-seed stage to 31.27% each at Series A, the value of their shares is now worth $9m each against the $9k each at pre-seed stage.
I hope you find this post useful.