Class 9 Notes

1. Class 9 Notes Valuation © Andrew W. Hannah

2. Agenda • Midterm Grades • Homework due tonight • Winning Angels - valuation • ContentSoft recommendation • Reflecting… • Recommendations • Valuation © Andrew W. Hannah

3. Reflecting… • What investors do – raise, invest, harvest • Angels vs. VC’s • History and trends • Fund economics • Investment models • Deal sourcing and screening (filters) • Deal evaluation (the entrepreneur and the pitch) • Due diligence • Deal Structure • Valuation • Contracts and terms © Andrew W. Hannah

4. Investment Recommendations • Goals • Present a clear picture of the company, product and opportunity • Present the diligence results in a manner that supports the recommendation • Basis for the recommendation • Markets – size, growth rate, key features • Competition – direct and indirect, key features, strength and weaknesses • Comparables – business model, financials, valuation • Valuation – how much? Exit and when? © William Hulley and Andrew W. Hannah

5. Investment Recommendations (Cont.) • What is included in the company’s plan? • The Overview – a presentation of the company’s plan • Market • Customer • Product • Management • Competition • Competitive Advantages • Financial Overview • The Diligence • Market • Competition • Comparables • Valuation • Recommendation – yes or no and why • The diligence memos (as appendices) ContentSoft Example © William Hulley

6. Valuation © Andrew W. Hannah

7. Why Are Companies Worth What They Are Worth? ICGE, Ariba, Cisco © Andrew W. Hannah

8. The Fundamentals of a Stock Price • Share Price= Company Valuation / # of shares • Company Valuation = Share Price * # of shares • Share price is what we follow but what is really fluctuating is valuation © Andrew W. Hannah

9. So What Is Valuation Anyway? • Theory versus practice • Theory : Discounted Cash Flows • Discounted = Net Present Value • Cash Flows = Expected cash inflows less expected cash outflows • Inflows = Cash from customers • Outflows = Costs to run the company © Andrew W. Hannah

10. Present Value Basics • Future Value • You have $1 • I guarantee you 10% interest for three years (or inflation is at 10%) • Your value: • Year 1: $1.10 • Year 2: $1.21 • Year 3: $1.33 • You are indifferent! • $1.33 in three years • $1.00 today © Andrew W. Hannah

11. Simple NPV • So…. • Discount Rate = 10% • Time = three years • Future Value = 1.33 • What is the NPV? © Andrew W. Hannah

12. Back to Valuation… • Valuation (NPV) = Discount Cash Flows over some period of time • Discount Rate = 100% (cost of capital) • Year123 • FCF $10 $20 $30 • PV Fctr 1 2 4 • PV $10 $10 $7 • NPV $52.97 vs. $27 © Andrew W. Hannah

13. The Real Calculation • NPV = Discounted Cash Flows (DCF) + DCF year ‘n’ / (cost of capital – growth rate) • Terminal Value = the new part • Discount rate = cost of capital • Rate you could borrow/obtain money at to grow your business • Lower the risk the lower the cost of capital • Low risk = Bank debt (8% or Prime + x%) • Higher Risk = Public Offering (20%) • Highest Risk = Venture capital (50%? 75%? Higher) • Growth rate = expected annual increase in cash flows © Andrew W. Hannah

14. NPV Formula – Cleaned Up • NPV = Future Value/ (1 + d) ^t • Future Value = cash flow • d = discount rate • Reflects cost of capital • Risk free rate + risk factor • t = time (“years”) • Terminal Value: cash flows in perpetuity = [FCF (year n)/ (d – g)]/ (1 + d) ^ n • g = growth rate of FCF in perpetuity © Andrew W. Hannah

15. Valuation Example • Discount Rate = 10% • Growth Rate = 4% • Year123TV FCF $10 $20 $30 $30 PV Fctr 1 1.1 1.21 1.21 PV $10 $18.18 $24.79 $413.22 NPV $466.19 • TV= [$30/(10% - 4%)]/ 1.21 = $413.22 (Revisit ICGE and CSCO) © Andrew W. Hannah

16. In the End.. • Valuation is based on expectations: • Are cash flow projections realistic • Growth rates • Risk of execution (discount rate) • Sustainable position • Ability to innovate © Andrew W. Hannah

17. Valuation Methods For Entrepreneurial Companies • Discounted cash flow? • Multiples of public companies and sale of private companies: • Sales • Earnings (current/future) • Customers? • Negotiation • Remember: discount rates = risk and required rate of return = cost of capital © Andrew W. Hannah

18. Valuation Methods By Stage © Andrew W. Hannah

19. What Makes a Difference? • The team’s experience • Stage of development • Customers • Protectable IP • Economic conditions • Size of the opportunity • Other © Andrew W. Hannah

20. Valuation Strategy • Entrepreneurs must triangulate (dcf and public & private multiples) • VC’s: • Discount projections • Look for 55% discount factor • Look hard at public and private multiples • Entrepreneurs best strategy: create an auction © Andrew W. Hannah

21. Pre- and Post-Money Valuation • Pre-money valuation = value of the company before the investment round • Post-money valuation = value of the company after the investment round • Example • You own 50% of a company • Pre-money valuation = $10 million • You are raising $5 million • What is the post-money valuation? • What is your new ownership percentage? © Andrew W. Hannah

22. Next Week • Contracts and Control • Diligence Card “B” – comparables • WA: 179 – 222 (this is different than the syllabus) © Andrew W. Hannah