Financial Modeling and Valuations for start-ups: Asset Based Methods

In a 5-part series, I will discuss the different aspects of financial modeling and valuing startups. Start-up life is (very) random while most projections and valuations are deterministic. A common misconception is therefore that financial modeling/valuations are worth little and a waste of time.

A good model is more probabilistic in nature and would greatly increase the understanding of both the founding team and the investors. I have developed a PowerBi model that is linked to Xero for historical data and an Excel financial model used for the projections. The aim is to make it easier for founders to update/maintain/fill in the financial model while at the same giving both the founder(s) and the investors more information, the ability to easily change assumptions and ultimately a more accurate picture of the company.

This is the link to the beta version of the Financial Model. Every week I will show a different part of the model to illustrate the discussed subject. For more information/questions/comments, please go to Vivolution or drop me a message.

Three valuation Methods

Valuing a company is not that dissimilar to valuing a property. Everyone who has bought or sold a house knows that there are different ways to value a property. Roughly speaking these methods fall into three categories:

1. Asset Based. How much would it cost to (re)build a property? If you know the average building cost per M2 and how large the house is, you can calculate the build cost.

2. Market Based. If houses are getting sold in the neighborhood, which are similar to your property, you can use the average selling price to calculate the price of your property.

3. Intrinsic Based. If a property generates a rent of ￡10K per year and you want to have a yearly return of 10% the value would be ￡100K.

Asset-Based Valuation Methods:

These methods do not use projections and are generally the easiest to understand but not very sophisticated. First, we will discuss 3 methods that we do not use in our model as it adds little relevant information and is too arbitrary. The last two methods, Score Card and Cost to Duplicate, we use in the valuation as we think it adds relevant information for founder and investor.

1 Berkus Method:

You assign a value up to ￡500K per category and add these up.

The valuation for this company would be ￡1.35 mln.

2 Risk Factor Summation Method

In this method, you compare the start-up versus an average industry pre-money valuation. The start-up is then scored against 12 different risk factors. A good score would lead to a bonus, whilst a bad score would lead to a malus.

The valuation for this company would be ￡4 mln.

3 Book value/Liquidation method

The book value of a company is equal to its total assets minus its total liabilities while the liquidation value is the book value if the assets need to be liquidated in a short space of time. In our model, we show the book value but will not use it in the valuation as it is very seldom an accurate picture of the true value of a company. The Cost to Duplicate method (method 5) is superior to these methods.

4 Score-Card Method (Bill Payne Method)

The first method we use in the model. This is the first method used in the model. As with the RFS method, you compare the start-up valuation versus an average industry pre-money valuation. By answering a series of multiple-choice questions (18 in our model) you will score the startup. These answers are then weighted and totaled. For instance, the weighted total score in the example below would 125.5%. If the average industry pre-money valuation is ￡ 1 mln the Score-Card valuation would be ￡1 mln * 125.5% = ￡1.25 mln.

5 Cost to Duplicate Method

The second method we use in the model is the Cost to Duplicate. What we try to answer is how much does a competitor needs to raise(spend) to build a similar product. We consider both actual cash inflows (from Xero) and non-cash input.

For instance, if a founding team has spent 5 man year developing a product and their market value wage would be ￡100K a year there would be ￡500k in unpaid wages. This amount is added to the actual cash inflow. The Cost to Duplicate is then adjusted by a multiplier based on 18 questions in the questionnaire to adjust for the general quality of the company.

Advantages Asset Based Methods

- Easy to understand.

- Can be used for pre-revenue companies without (good) financial projections.

- The Cost Duplication method can be the floor in a valuation calculation as a

competitor/buyer would need to spend the same to get to a similar position.

Disadvantages Asset Based Methods

- These are unscientific methods with no real justification for the weightings used in the calculations.

- It does not consider future profitability.