April 13th, 2009
That company is worth what?!
Company valuations.
Now that I’ve been staring at pro-formas for weeks and have officially re-kindled my love affair with my TI-83, I am sort of in love. What’s great about MIT is they don’t spoon-feed material – we got a packet of financial statements and just had go at it. Mk, on to the good stuff.
Apparently there are 20+ ways to do valuations, but they all fall into five general buckets.
For the uninitiated, here is my attempt at a breakdown:
1. Earnings Multiples (PE, EBIT, EBIAT): Methods that employ an industry-based multiple to the earnings of a firm. If a firm has no income (ahem, Twitter), its valuation using this method would be effectively zero. The most popular earnings multiples valuation uses a company’s price:earnings (PE) ratio — if you multiply the PE ratio and the company’s net income it will give you a general idea of the value of the business.
2. Asset Multiples (Liquidation Value as Percentage of BV, Replacement Values): This is when you liquidate the assets of the company, pay off your liabilities, and see how much is left.
3. Discounted Cash Flow (DCF): You use future free cash flow predictions, then discount them back to adjust for the time value of money. The most popular method of discounting uses the weighted average cost of capital – or “WACC”. There are a lot of WACC jokes in business school, and aren’t they just so hilarious? (You wonder why the MBA has taken such a reputational hit lately).
4. Comparables: Exactly what it sounds like. Use the valuation of similar (ahem “comparable”) companies to arrive at a valuation. Simple comparables worksheet: here.
5. Contingent Claims: This type of valuation involves derivatives (options). And that’s all I’m going to say about that.
So how are early-stage tech companies valued? If you have little to no revenue, earnings multiples and dcfs are sort of useless, and trying to ascribe value to site traffic and “intangible assets” is an onerous process.
This paper written by Cogent Valuation lays out what they call the “Early-Stage Technology Company Valuation Paradigm” – it’s a fairly straightforward explanation of their valuation process for these types of companies (though I sort of loathe excessive use of the word “paradigm” especially in reference to already hard-to-grasp topics like valuation).
This is a new topic for me, but I’m hoping by the end of my time at school I can produce the following post: “HotorNot: An Analysis of Valuation Methods for Early-Stage Technology Companies”. Stay tuned…