Valuing your Startup - Part 2

Depending on whom you ask, there are a number of ways to value your startup. I will, however, categorize them into 2 broad segments Intrinsic Valuation and Relative Valuation.

Intrinsic Valuation

The intrinsic valuation tends to value the startup solely based on the perception of its true value. This perception is usually based on the startups’ financial performance and potentials. Most times, the intrinsic value is based on the free cash flow of the business. It is calculated as the net present value of the future cash flow of the business. I will however not get into the details of this because it is mostly not applicable to early-stage businesses.?This is because you are required to project the future cash flows of the business based on its historical performance and future strategy. However, since we do not have sufficient historical context, justifying the forecast will be extremely difficult.

This method is best suited for most mature companies.

Relative Valuation

The Relative Valuation, on the other hand, is an attempt to value the business based on the valuation of a comparable business. This is less technical and much more applicable to most startups.

Let me explain this in a really basic term. Imagine you want to value PrepClass for instance. Relative valuation suggests that the valuation multiple of PrepClass will be similar to that of Tuteria or other Edtech businesses operating in Nigeria with a similar model.

I believe the most difficult part of the relative valuation is identifying the comparable companies as well as finding the applicable multiple. This is difficult because most private companies do not disclose their valuation information publicly.

In identifying the comparable company, you need to find businesses operating in similar markets. Say emerging markets. Then you find businesses at a similar stage as your startup. You will be comparing Apples with Agbalumo if you compare the valuation multiple of PayPal with PayStack. The markets are different, so also is the stage of the businesses.

Hence the difficulty. It is largely difficult to find a perfect comparable in a market like ours, that is why POOTA is important (I explained POOTA in my previous post). In a situation where you are condemned to using a semi-perfect comparable, there are adjustments that can be made to reflect the stage or the market of the Target startup. It is also best practice to use more than 3 comparable companies and weed out outliers. This will give a much more robust valuation picture.

There are 2 major valuation methods that we will discuss – Precedent Transaction Multiples and Comparable Trading Multiple.

The Precedent Transaction Method suggests that the price paid for similar companies in the past is considered an indicator of a company’s value. While Comparable Trading Multiple is similar to the Precedent, only that the comparable companies are trading in the public market essentially. Like you must have suspected, we won’t be able to use the Comparable Trading Multiple because of the stage of our startups.

Valuing BookNow.ng

I will explain this in practical terms using a hypothetical scenario. Our Hypothetical startup is “booknow.ng” an online travel agent operating in Nigeria. BookNow is looking to raise $4.5m in Series A capital to expand to (you know the usual suspects) Ghana and Kenya. BookNow has been operating for 3 years. So, we will use the Relative valuation method to value the business.

Traditionally, an E-commerce business is valued based on its GMV – Gross Merchandise Volume. This refers to the total volume (in the currency of measure – USD) of sales over a given period (Say 1 year).

To explain this, imagine you booked a hotel on BookNow.ng for a night at N50k. The N50k represents BookNow’s GMV. BookNow can then charge the hotel 10% of the transaction value – N5k. The N5k is then the net revenue for BookNow.

Getting into it, imagine BookNow generated a total GMV of $20mm in in FY 2017. In determining the valuation, we will look for comparable companies operating as an Online Travel Agent. An Online Hotel Booking platform should not be considered as a comparable. This is because the Online Travel Agent’s GMV can be skewed based on Airline bookings, which is typically more than hotel room bookings. These comparable companies should also be operating in similar markets. See below the list of hypothetical comparable companies;

Now that we have our comparable companies, we will then apply our multiple to the GMV of our target company – BookNow. There are a few tricks you can use here to get a higher valuation, but those are discussions for another time. Just to drop a hint, you can manipulate your Comps, by excluding the low multiple Comps and leaving only the ones with higher multiples.

For this analysis (fair), I will be using the Median value for my analysis. Why not Average? You might want to ask. The average value has been skewed by the outliers – SafariTrip especially. So, the Median actually represent the true picture of the Comps

Then you apply your selected multiple on the GMV of your Startup to get your ideal valuation number. This number can then be sensitized, but leave that to financial analysts to figure out. The idea of sensitivity is to understand how any change in certain variables (Multiple, GMV) would affect your valuation number.

Dilution

The other thing to understand is the dilution impacts. Now that we have gotten our ideal valuation number (Pre-money), this suggest that this is the valuation of the company before any capital injection. But don’t forget, BookNow is raising $4.5m. What we are trying to get is how much stake the new investors will get at this $24.3m valuation.

This implies that new investors will get 15.6% stake in the business while existing investors will maintain 84.4% stake in the business.

Capitalization Table

Cap Table as we like to call it provides an analysis of a company’s percentage ownership, equity dilution and value of equity in each round of investment by founders, investors and other shareholders. Don’t forget that BookNow has raised a previous seed round of $1.5m before the current Series A round. BookNow also has 2 co-founders who work as the CEO and CTO.

3 investors participated in the previous Seed Round, while 2 investors participated in the current round. The seed round was concluded at a $7m Pre-Money valuation. So the Capt Table will capture the shareholding of the business since its inception to date.

The table shows the dilution impact of each capital raising round on the existing shareholders. Though the founders’ stake has been diluted from 45% each at the Pre-Seed stage to 31.27% each at Series A, the value of their shares is now worth $9m each against $9k each at the Pre-Seed stage.