Is there a decent way to calculate valuation? We're starting to be approached with merger/acquisition talk and we're unsure on how to best determine our value in that scenario.
We're a 2.5 yr old company, annual revenue for this year forecasting to $1.1M. (2013 was $360k, 2012 was $60k). We're a team of 5 salaried employees (founders included), bootstrapped, fully employee-owned and steady revenue growth with very low operational costs.
Meritt,
ignore DCF's - they are utterly useless in the tech / venture world, especially at the stage you're at. Look at it more as "what value are you providing to the firm" - everyone and their grandmother will claim that its strategic (ergo, justifying high valuations with non basis in financial reality), but very few can pull that off. Failing that is if you can show how valuable you can be to that firm - ie, to use a simple example, if using your approach can provide them with a 5% uplift on their typical sale). Otherwise, its an opportunity cost thing for you - what is your logical upside at a more mature stage, and what is your self-perceived probability of getting there? You don't have to sell, which makes it very powerful.
"Meritt, ignore DCF's - they are utterly useless in the tech / venture world, especially at the stage you're at."
I wouldn't say they're utterly useless. The thing is, they're starting points. DCF isn't the beginning and end of a valuation process; it's a guessy data point. But it's more educated than a lot of other guessy methods. At the very least, it serves to ground the acquiring company's expectations.
I wouldn't rely on a single, straight-line DCF for a startup. Ever. But model out a few scenarios, and play around with a few factors, and you arrive at a sort of distribution of outcomes. That distribution requires an an asterisk, but it isn't useless.
Also, in the event you're being bought by a publicly traded company, somebody there needs to present some sort of NPV-based analysis to someone. If you're a small acquisition, that may be a mid-level manager to the VP level. If you're a big acquisition, that'll be the C-level to the Board (and indirectly, to Wall Street).
Here's one way to figure out the valuation of your bootstrapped company.
If you continue running the business and pursue your current operating plan, how much cash will you have in the bank in year 5 and year 10? (Broad estimates are fine)
Generally speaking, your year 5 and year 10 estimate is going to represent a reasonable approximation of your company's valuation range.
For example, let's say you believe you will have $5.5m in the bank in year 5 and $12m in the bank in year 10. Your valuation will approximately be $5.5m to $12m.
Financial buyers will generally offer $5.5m. Strategic buyers will generally be willing to pay $12m or more depending on the prospective synergies/option value of the assets.
That said, you'll need to ask yourself how much money are you willing to accept today to walk away from $12m over 10 years. Are you willing to accept $5.5m in exchange for more freedom/time to devote to other things that may add more personal/financial value over those 10 years.
(Many startups are optimizing for high option value and this approach might not be appropriate for those companies)
Comparables are good, but you may also want to check out Aswath Damodaran's work. The simplistic version is to do a discounted cash flow analysis and use comparables to get an idea on the discount and other variables.
What have comparable businesses raised capital at? Think about it as a calculation like V = P x M (Valuation = Profit x Multiple; sometimes you'll use Revenue instead of Profit). The Multiple is the magic number.
I'm helping a seed round at present, and we managed to find several 'competitors' who raised several rounds each at a fairly consistent Multiple. We have subsequently used that to explain the discount valuation we're using.
Crunchbase is a good place to start, and in a big enough market with good google-fu you'll be able to gather the data to support a Valuation.
Generally speaking valuation is speculative. Think of it this way - a gallon of milk is priced at $3 because that's the price people are willing to pay for it. If it was $10, no one would buy it and if it was $0.01, they'd run out of supply. Same thing goes for business. The valuation is whatever people are willing to pay for it. If I buy milk for $3 it's because I know if I consume foods right now it will give me energy so I can do more things later in the day. Some people create a story speculating that a particular gallon of milk has the ability to give you twice the energy, so they'd price it at $6. These stories turn out to be true sometimes and sometimes not. Hence, why today valuations are considered crazy because everyone is painting a unicorn story.
A few factors go into valuing a company, which potentially aid the craze:
1. There is extremely low liquidity in non-public markets for investing. In other words, you don't have a millions of people in the US investing in startups every day. In a perfectly elastic market, valuations are 100% correct. Due to the high liquidity and number of actors, public markets are much better at reaching perfect elasticity whereas private markets are not. In other words, less actors dictating how much they are willing to pay for something means higher deviations from the true price.
2. Many tech companies are irregularly (irregular in relation to existing companies) evaluated today because they do not follow traditional investment metrics. This is largely set by precedence. When Facebook and Google IPO'd, the investing community was fairly clueless as to how to evaluate these companies. The metric they've chose is DAU/MAU because it translates into how much attention "land" they can acquire to resell to advertisers and hence increase revenues and profits. Now that these are "the metrics" it means every other "tech startup" is in a land grab to attain those numbers quicker anf faster than before. This is why Instagram and WhatsApp had such high valuations...their DAU/MAU's were crazy high and growing at faster rates than Facebook itself.
Generally, the larger investing community values companies based on earnings. EBITDA is usually a popular metric to do this, but one metric can't dictate everything about the valuation. Valuations are based on a series of metrics, a multiplier, all based on the speculative return of buying the business. So for example, a company a one-year $1.1m budgeted forecast might be speculate to be worth $5mil simply because the revenue growth trajectory means they can return. Now add in a multiplier of 2.2x because your team is a group of badasses and your contracts last 3 years, and bam your company is worth $11mil.
Because tech markets have high growth potential (Uber is quoting to having had doubled their growth every 6 months) it means the valuations are abnormally higher than many other businesses. How many hair salons do you know that are doubling revenue every 6 months and have relative businesses who have shown similarly consistent growth in that market?
All things being equal, the question ultimately becomes "what part of the hockey stick am I on?".
>If it was $10, no one would buy it and if it was $0.01, they'd run out of supply. //
Do you think? Milk is a pretty much fixed use rate for homes I feel - low cost milk is probably more a loss-leader than anything else. If there's a crisis in the dairy industry those who can afford to pay $10 probably will for quite a time. The reason my supermarket doesn't charge more is competition. Milk is fungible, largely, hence competition plays a more important role [we buy Organic milk wherever possible however]. Most tech isn't so fungible.
I guess how that feeds in to your valuation analysis is that USP is important? Even if your business amounts to just another messaging app, or another photo app, you can have a USP - like Whatsapp's user base?
... if milk were 1¢ I'd take up cheese making; cheese is so expensive.
compare your revenue growth rates, earnings growth rates, gross margin and other metrics to similar public companies. Then looks for a price/sales figure (or forward price/sales figure). Based on the info you've given, your company is probably worth around $20 million at the moment.
We're a 2.5 yr old company, annual revenue for this year forecasting to $1.1M. (2013 was $360k, 2012 was $60k). We're a team of 5 salaried employees (founders included), bootstrapped, fully employee-owned and steady revenue growth with very low operational costs.