New Feature: I-Banker Style Excel Comp Sheets

Hey everybody:

We released a really cool new feature a few days ago: investment banking-style excel comps lists. Registered users can download these type of comp sheets from any of our 700+ (and growing daily!) pre-made lists or, as always, they can create their own customized lists and download them. Remember M&A data is only available to our premium users--at the bank breaking price of $20 / month. In all seriousness, we will probably raise our prices for new users at some point, so join now while the beta pricing lasts!

Here is a list of "comps" for Solar Power Generation using our latest feature that we thought you might like.


SolarCompList.xls

The Beauty and Limitations of Multiples

OK, so let's talk multiples. I know that this is so exciting to some of you that you can hardly wait. In all seriousness though, multiples are one of the funnest parts of entrepreneurship, VC, and private equity. Multiples are put simply numbers that you can multiple against the operating metrics of a company (like revenue, EBITDA, cash flow, downloads, monthly unique visitors on a site, etc) that yield a rough valuation estimate for that company. We use multiples as the basis of our valuation work at http://www.venturereturns.com/. We kind of consider ourselves multiples junkies. So what is so exciting about multiples? Lots of things, so I will go into more detail here.

Simple to use. One of the coolest things about multiples is that they are simply to use. It is often very hard to find the right multiples, but once you find them, they make valuing a company easy. VR makes finding them easy for you (http://www.venturereturns.com/company_komp_builder.php?newFlag=N&pType=5). Now, for example, let's assume you are interested in the value of a particular Saas (software as a service, like Salesforce.com) company. Saas multiples are really high right now--generally between 6-8x revenue and 30-40x EBITDA. This means that if you have a Saas company doing $5M in revenue, it could be worth up to $30-40M.

Multiples yield business insight. Multiples can actually teach you a lot about different businesses. For example, they can basically tell you what the value of $1 of revenue in one kind of business is worth versus the same amount of revenue in another business. Again, let's take Saas as an example. Let's compare Saas to hardware companies. Hardware companies are lucky if they can get 0.8-1.5x revenue multiples. The revenue multiples teach us that $1 of revenue in a Saas business is worth about $6-8 of hardware business. This can be instructive as entrepreneurs are considering business opportunities, as VC and PE investors are looking at deals, and as businesses are making investment decisions. I can promise you that any investor worth his or her salt will think carefully about multiples. Most big institutional investors only want to make investments where they can reasonably expect a chance of at least a $100M exit. For larger funds, this can be an even bigger number. For Saas companies, you could expect this kind of exit by generating $12-17M in revenue. For hardware companies, you could only expect this kind of exit by generating $100M in revenue. BTW, this doesn't mean that you shouldn't start a hardware company necessarily--you had just better realize that it brings a unique set of challenges. For a variety of reasons you may want to couple a software company with a hardware company (think Blackberry). This kind of thinking is also helpful when you think about strategic investment decisions in a company. I was recently talking with an entrepreneur acquaintance who does generates 20% of his business from a traditional enterprise software product and 80% from a Saas product. The enterprise software product has much longer sales cycles, costs a lot more to manage and deploy, and is a giant pain to maintain relative to the Saas product. I told him that I thought every dollar of Saas revenue was worth $2-3 dollars of enterprise software revenue and that I would seriously consider abandoning any future sales of enterprise software just to focus on the Saas business. Maybe I was wrong but multiples can clearly inform this kind of thinking.

Multiples generally point to a leveraged exit. One of the exciting things about multiples is that they remind us that modern finance has taught us that indefinate streams of cash flow can be equated to a lump sum payment now. Further, we know that the lump sum payment now is generally bigger than the cash stream. This fact sits at the foundation of modern entrepeneurship on both the early-stage and late-stage sides of the camp. Nearly all venture or private-equity backed investors and entrepreneurs are not interested in creating busineses that simply generate a healthy cash flow indefinately. This might be nice for those entrepeneurs looking to create a lifestyle business but it doesn't work for investors because they have to give money back to their investors in some reasonable timeframe--typically within 5-7 years. So for VCs and private equity investors, they need to believe that they will be able to convert a cash flow stream into a lump sum return within about 5-7 years. Multiples remind us what we can reasonably expect here. The great news is that while you may not be able to live high on the hog while you are building your business, you should be able to look forward to a time when you get a really nice payment.

So what are the limitations of multiples?

I may have to talk about this more later because I promised my wife I would go downstairs. However, here are my initial thoughts. Obviously multiples are not a full blown analysis. In fact, they are not even close. At VR, we use a multiples-based method due to the scarcity of data on the companies we are valuing. While they aren't perfect at all we do believe that they can give enlightening information about valuation ranges, industry /company valuation trends, etc. At the end of the day some form of comprables analysis will always be the critical foundation to any valuation of a private company.

Early-Stage Valuation 101: The Venture Capital Method

Ok. I hope to make one thing clear. Almost all of us here at VR have significant valuation experience. That said, there is nothing about valuing an early-stage venture that is easy. Anybody who tells you otherwise is not telling the truth. Valuation at its root is ultimately an exercise in extrapolation. The appraiser must project financial results forward and make assumptions about future results. Despite what the mutual fund prospectus claims "Past performance may not be an indicator of future results," most of business planning and certainly most of valuation depends on past results as the primary input. If one thing is clear about early-stage valuation, there is almost no past performance upon which to base an extrapolation.
This is where early stage VCs really envy their later-stage brethren and sistren. Later-stagers go to work with reams of historical data. More importantly, they can actually model valuation on profitability data--most notably EBITDA! Early-stage VCs have to make use of revenue. Revenue is notoriously uncorrelated with cash flow and ultimately a business is as valuable as the present value of all future cash flows.

Let's look at the 3 basic kinds of business valuation:

1. The “Cost,” or “Underlying Asset” Method. This method examines all of the assets and the liabilities of the companies and adjusts their book value to market value. The value of the equity of the company is equal to the market value of the company’s assets less the market value of the company’s debts. For most startup or rapid growth private companies, this method is not accurate. The method inherently assumes that a company is only worth the market value of its assets less its liabilities. However, most investors invest in startups and rapid-growth private companies precisely because they believe that the value of the company far exceeds the value of the assets less the liabilities
2. The Discounted Cash Flow (or “DCF”) Method. This is one of the most widely used valuation methodologies. Essentially, the method starts by projecting future cash flows of a business for a defined period (the forecast period) and discounts the value of these cash flows to the present. The method then requires estimating the value of all future cash flows after the forecast period. This value is called the terminal value. The appraiser does this by dividing a terminal year cash flow by a terminal value discount rate. The sum of the discounted forecast period values plus the discounted terminal value equals the value of the company. While this method is probably one of the best methods for companies with predictable cash flows, it breaks down when the appraiser cannot accurately predict cash flows for a forecast period. Because many early-stage startup companies do not have stable or reliable cash flows, this method is often not effective or requires significant adaptation.
3. The Multiples Method. The multiples method actually describes a range of related valuation methodologies. Essentially, the multiples method entails multiplying a specific ratio to the target company’s revenue or income to estimate an overall company value. The appraiser derives the appropriate ratio by considering ratios of comparable companies. The multiples method and DCF methods are highly related in that multiples applied to revenue, earnings, income, EBITDA and other cash flow metrics are simply inversions of the “discount rates” which form the basis of the DCF method. In this sense, the multiples method is actually just a simplification of the DCF method. The multiples method is often useful to help the appraiser quickly get a valuation estimate. Further, the multiples method does not rely on a detailed forecasting of cash flows.
4. The Option Method. The option method is a sum-of-parts valuation methodology that models the components of the company’s capital structure as call options and sums the result. Essentially, this method treats all debt and equity securities of the company as call options on the Indicated Value of the company at some future date. This future-date Indicated Value is the expected value of the company in a future liquidity event like a sale, merger or IPO. The exercise prices of these call options are staggered based on the priority of returns for different securities. There are several methodologies for applying option valuation to company valuation but most appraisers favor the Black-Sholes methodology. Appraisers often use this same methodology to allocate the value of the company to a target security. However, this method does not help us to estimate the future Indicated Value of the company, so most early-stage appraisers use the venture capital method for that.

Venture capitalists, appraisers, and other industry experts almost universally use a hybrid method, the “First Chicago” method or “Venture Capital Method,” to value startup companies. Practitioners of this method point to the method’s simplicity, its focus on a small set of data-driven assumptions, and its widespread adoption in the venture capital industry as positives. The Venture Capital Method relies on several fundamental assumptions:

1. That the appraiser can accurately forecast projected revenues
2. That the appraiser can accurately identify an exit value, or the value at which the company will be sold in the future
3. That the appraiser can accurate discount the projected future returns to the present

The Venture Capital Method

The Venture Capital Method basically applies valuation multiples (derived as described above in the Multiples Method) to a future cash flow period. This is often referred to as the “exit value” or the assumed valuation placed on the startup or growth company by an acquiring entity or the public markets in an initial public offering. To arrive at the current value of the company, this value is discounted back to the current time period using discount rates. We use different discount rates at the following stages. These discount rates are based on years of academic research.

• Seed or Startup stage. These companies are typically actively engaged in product design and development. They are not generating revenues and may not even have a prototype product developed.
• Pre-Revenue with early product prototypes. As the title indicates, these companies do not have revenue or significant revenue but have developed a prototype product or have a functional product but have not shipped the product yet.
• Shipping product. These companies are shipping product and have some revenue but the revenue may still be small and growing. These companies often still require significant investment to scale the business.
• Expansion stage. These companies are growing rapidly. Sometimes these companies have positive income but many choose to reinvest cash flow into growing the business which limits income.
• Profitable and growing. These companies are typically solidly profitable. If they are not profitable it is simply because they are clearly reinvesting a healthy cash flow into growth opportunities. They may still desire to raise capital for growth.
• Bridge or Mezzanine stage. These companies are performing well enough that they are considered likely IPO candidates. They need funding only to get them to their IPO which will likely occur within 6 months.

Company Valuation for the Masses

One of the things that we are hoping to do is introduce an ability to extend valuation of companies (especially private companies) beyond the typical realm of sophisticated analysts at investment banks, venture capital firms, and private equity funds. Don't get us wrong, in many ways our primary user group target is the gals and guys of Wall Street, but we also view part of what we are doing as trying to become a Zillow.com-like tool for the valuation of companies instead of houses. You can see our valuation tool here. We are working on releasing a Flash demo that will show you how to use it but in the meantime you start by essentially searching for comparable companies using our free text search or by looking through a sector tree we have created. From here you simply drag and drop companies that are comparable over to the "Select Comparables" box. Once you have done that, we automatically go out to the public markets and pull in the appropriate valuation ratios. We also search our own proprietary database of M&A transactions and use those as comparables as well. Finally, we ask for very simplified view of your income statement (basically revenue and EBITDA), cash on hand, and debt on hand. Based on this information we can give you a rough estimate of what your company is worth. We can also create a stock chart for your _private_ company. Over time we hope to add a lot of features here. We are pretty excited about it. That said, you should keep in mind that this represents only a rough estimate of the valuation of a company. If you are interested in a full-blown valuation, we offer those as well. We call them 409a valuations (because these are the type of valuations we have most often been asked to perform) but essentially we can perform any kind of appraisal or valuation for you. Look here for more information.

How We Got Started

I don't know about you but I enjoy reading about the founders of cool companies. I think that VR is a cool company so I am hoping that some of you might be interested in how we started it. VR really started up at the Harvard Business School in 2004. There were several of us who had entrepreneurial backgrounds who really wanted to work in VC, but the chances of getting a job in VC were kind of similar to the chances of the Boston Red Sox winning the world series before the curse was lifted (and it was lifted as the Yankees will see in the post-season). We applied for positions but none of us got jobs. So we opted to do what we had always enjoyed--start a company. One of the companies we started was originally called Venture Engine. The idea behind Venture Engine was to turn the tables on venture capitalists a little--not in any kind of particularly spiteful way--by allowing the entrepreneurs who worked with them to confidentially rate their experiences working with the VC. The idea actually camewhile some of us were watching a Red Sox game in The Grille restaurant. We were thinking about the book Moneyball and about how much data we gather on professional baseball players. It led us to think about how much data professional public equity investors gather about publicly traded companies and how little data is available about private companies and their investors. We kind of thought that the private equity industry would follow the path of most other cottage industries. It would start out as small and clubby with very little information available to outsiders, kind of like the early days of real estate investing. Then just like real estate investing, information providers would crop up and start providing more information about the industry, about its investors, and about deals. Think about MLS for example, or its web 2.0 peer Zillow.

Anyway, we envisioned selling entrpeneur's ratings of VCs to the VCs themselves and to the large institutional investors who invest in VCs. We launched the company in earnest in Q3 2004 and started gathering data from entrepreneurs in 2005. We ultimately changed our name to Venture Returns. While entrepreneur ratings were the genesis of the idea, we never really wanted this to become the centerpiece of what we were trying to do. We always dreamed much bigger and as you can see on our current site, www.venturereturns.com, we view this as only one of many services we offer to our user community.

I don't want to talk too much about our grand vision because there are some competitors out there, but let met just say we are excited about what we think we can offer our core community of entrepreneurs and the VCs and private equity professionals who invest in them.

One of the tools that we have launched is a valuation tool for private companies. We recognize that valuation is a very tricky art and science. Some of us, myself included, have actually spent years doing these kind of valuations. We didn't build this tool as a professional, perfect way to create a valuation of a private company. Rather, we think of ourselves more like Zillow.com, in the sense that this is a first-pass rough estimate of the value of your company. As we gather more data and as we refine our model we think that it will become quite accurate. Also, the tool allows deal professionals (private equity gals and guys, VCs, and investment banking pros for starters) to find comparables in a much quicker and efficient way than they have historically. Selecting the right set of comparables in valuation work is always tricky. We have created a tool that should make this dramatically easier. While we may not be able to take the art out of selecting the right comps, we can assure you that our comp data is solid. We get our public comp data directly from stock exchange feeds and we update these feeds every day. Further, we gather and quality check our own M&A data. Right now the tool works only for technology companies but we are in the process of expanding it to all companies.

Here is a picture of a quick valuation that I did for a friend of mine who has a security software company that is growing nicely and has significant trailing revenues and that recently hit profitability. WARNING: the picture looks awful unless you click on the little expand button down at the bottom of the page. Sorry I need to convert this to a .jpeg and re-upload sometime later.