S TA R T- U P S
40 · MONEY
ISSUE 54
Patrick has worked in the financial sector for 10 years. His job as private equity associate includes evaluating new investment opportunities and optimising portfolio performance. Patrick holds a CPA warrant and is a CFA charterholder.
VALUING START-UPS: Valuing start-up companies can be tricky. Patrick Debattista shares some ways on how best to value start-ups.
As at 2016, there were around 300 million persons worldwide trying to start 150 million businesses in the countries covered by think-tank Global Entrepreneurship Monito1. Assuming one-third of these operations were formally launched (a conservative assumption), this translates to 137,000 new businesses per day. Unfortunately, much of what we learn in finance and economics is based on the premise that companies are mature and stable. This means that the realities of at least 150 million businesses worldwide (per annum!) are being largely ignored by our textbooks. In this article, we will try and bridge this gap by understanding how start-ups differ from other businesses in terms of their valuation. The concept behind a start-up Most start-ups share a set of common characteristics: they are innovative, they are formed on a (usually) ground-breaking idea, and there is no prior track record precisely because they are brand new. All of this makes their valuation more challenging than traditional, more mature companies. One of the first concepts that a start-up valuer must understand is that the company’s key assets are likely to be intangible. Back in 1994, Jeff Bezos (pictured) started Amazon in his own small garage with nothing but a computer, a desk and some million-dollar 1 This is according to Dr Paul Reynolds, Director of the Global Entrepreneurship Centre’s Research Institute. 2 Zoox is currently valued at $3.2 billion in some quarters. Source: Bloomberg.
ideas (i.e. intangible assets). The company is now worth almost $800 billion and, as a result, Bezos is the world’s richest man. These intangible assets could be disruptive ideas, perhaps supported by a technological platform. Equally, they could be their entrepreneur’s creativity, their capacity to endure the difficulties of initiating a business, and the continual development of ideas. Several now-mature businesses once shared all these characteristics back in their start-up days. Google, Facebook, Apple and Microsoft are the most obvious examples of this. The valuation of start-up ventures usually varies with competition for capital and the business cycle. For instance, some sectors have more capital chasing deals than others, while investors are less inclined to provide equity if the economy is in recession or if a slowdown is on the horizon. An abundance of capital would drive valuations upwards, while a recession or potential slowdown would lower them. Valuation multiples (market or firmspecific multiples) One method to value start-up companies involves applying a multiple to one of the firm’s operating metrics, e.g. sales, earnings or cash flows. This multiple could be based on what publicly-listed comparable firms are trading at in the stock market. However, the difficulty here lies when there are no listed comparables to our start-up operation. For example, how would one have valued Facebook back when it decided to go public? How would one value Zoox, a self-driving taxi company2?
