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Valuation

When we focus on valuing, a company, there are three main valuation methods used globally. The key valuation approaches are:

Assets approach

The approach best fits while valuing a company that is capital-intensive and holds significant investments in the form of capital assets. The companies that have a large volume of capital work in progress can also be valued using an asset-based approach. The method is widely used for valuing the shares during a time like amalgamation, absorption or liquidation of companies.

Income approach

Again a widely used approach, where the practitioners use two different methods based on the company being valued. The approaches are Discounted Cash Flow (DCF) and the Price Earning Capacity (PEC) methods. The DCF approach uses the projections of future cash flows to determine the fair value. The method can be used only in cases where information /data is readily available. On the other hand, the PEC method uses historical earnings for valuation. In cases where a company/ entity has not been in existence for a long time(or has just recently started operations), the method cannot be applied for valuation.

Market approach

The approach uses the market value of the company’s shares for its valuation. The approach works only when the company is listed in a national or international stock exchange, and hence the share prices are readily available. The approach sometimes can leverage the company’s peers' share public prices for computations as a proxy as well. When it comes to share valuation, there is no ONE valuation method that fits all requirements all the time. Different methods of share valuation are used based on the purpose of evaluation, availability of data/information, the nature of the business, volumes the company deals with, and more.

The three most sought after share valuation methods today are:

Asset-based share valuation

The approach uses the value of the company’s assets and liabilities (including intangible assets and contingent liabilities) to come with a valuation. The approach finds application with manufacturers, distributors, etc. who hold a massive volume of capital assets at any given point in time. Many times the approach is also used along with the valuations derived from other approaches, for cross-validations and confirmations.

In this valuation method, the practitioners divide the company’s net assets by the number of shares, to arrive at the value of each share. Here are some of the key points to be cognizant of, when computing the valuation of shares using this approach:

  •  Consider all the asset base of the company for computations,
    including the current assets and liabilities (such as receivables, payables, provisions, etc.).
  •  Consider the fixed assets of the firm at their realizable value.
  •  Incorporate the valuation of goodwill, as an intangible asset
  •  You must also consider even the unrecorded assets and liabilities (if any) while computing
  •  While computing, remove all fictitious assets like the preliminary expenses, discount on issue of shares and debentures, accumulated losses, etc

Deduct all the external liabilities from the total assets (of the firm) to assess the net value of assets. Divide the net value of assets determined by the number of equity shares to get the value of each share.

Income-based share valuation

This approach is used when the valuation of only a select few numbers of shares is to be accomplished. Here, the focus is on the anticipated benefits from the business investment i.e the profits the business is projected/expected to generate in the future. The most popular method practiced for business valuation is by dividing the business’ expected future earnings by a capitalization rate. Discounted Cash Flow and Profit earnings capitalization are the two methods most prominently used. PEC is ideal alike for an established entity, newly started business and companies with volatile short-term earnings expectations. A more complex analysis such as discounted cash flow analysis can be used if there is a dearth of data.

Value per share is computed based on the company’s profit available for distributing amongst stakeholders. Practitioners deduct reserves and taxes from net profit to arrive at the profit available for distribution. Here are the steps that need to be followed to come up with the value per share using the income-based approach:

  •  The company’s profit (available for dividend) - Get this information
  •  The capitalized value data- Get this information
  •  Compute the share value (Capitalized value/ Number of shares)

Market-based share valuation

The market-based approach is not as direct as the first two ones. The method uses the share prices of comparable publicly traded companies (key competitors of similar size) and the asset/stock sales of comparable private companies as a proxy. Data related to most of the private companies (which is not available in open sources) can be gathered from different proprietary databases available in the market. However, choosing comparable companies can be tricky and requires a lot of work. You must keep many pre-conditions in mind while selecting the peers/comparable companies. Look at the nature and volume of the business, industry, size, financial condition of the comparable companies, the transaction date, etc. to identify similarities and strike out differences if any.

There are two different methods when using the yield method (Yield is the expected rate of return on investment) they are explained below:

  •  Earnings yield method:  Shares are valued on the basis of expected earnings and the normal rate of return
  •  Dividend yield method:  Shares are valued on the basis of expected dividend and the normal rate of return

Our valuation approach across all the methods includes a deep analysis of all the complex factors involved. We go deeper with technical rigor and industry expertise to offer flexible solutions to our clients. Our services include business valuation and the valuation of a company’s equity and assets (tangibles and intangibles). We offer valuation service for regulatory purposes, for dispute valuation and strategy related valuation (like financial modeling).

Startup valuation

Valuation of business, in general, is complex, and even more when the business is a startup. Most startups offer unique products and services and rise to glory within a short span of time, disrupting the traditional ways of doing business. Hence the valuation for business for startups with revenue or profits is not straightforward. Valuing a startup business becomes a more complex task compared to listed companies that already have steady revenues and earnings listed. Valuation of a Startup is influenced deeply by the market and industry forces in which the company is operating. The value also depends on the demand and supply of money, similar recent transactions, how invested (with time and money) the promoters are, funding history and willingness of the investors to pay a premium.

Startups have seen unprecedented growth across the globe, making it large within a short span of time. India is one of the largest economies in the world and home to many disruptive startups. We are amongst one of the world’s fastest-growing economies, with a large consumer base and demographic dividend. The reforms and measures the government is taking to boost trade are further giving a boost to startups in India. Newer opportunities for startups in the area of artificial intelligence, machine learning, the internet of things (loT) and other digital technology initiatives are emerging.

The DIPP’s defines a Startup as

Startup refers to a legal business entity, incorporated or registered in India:

  •   < Seven years old (exception- biotechnology startups not prior to ten years)
  •   The annual turnover < INR 25 crore in any preceding financial year, and
  •   Working towards innovation, development or improvement of products or processes or services or a scalable business model that has high potential to generate employment or creation of wealth.

DIPP also mention that the startup must

1. not be formed by splitting up, or reconstruction, of an existing business

2. Startup shall be eligible for tax benefits only after it has obtained a certificate from the inter-ministerial board, set up for such purpose.

Startups from a financing perspective process the following key characteristics:

  •   The capital structure is complex
  •   Most have a high dependency on external sources for financing
  •   Promoter contribution in financial terms is limited
  •   Financial projections made are optimistic
  •   Some may have negative cash flows, with limited sales

Differentiators for Startup Valuation

In comparison to the valuation of operational entities, the valuation of Startup is tricky. Here are some of the key reasons that make valuing a startup challenging:

  •  Zero or negligible experience of doing experience
  •  Most do not have an established brand for the products and services
  •  Sometimes the entities many not have key identified human resources (not always, but sometimes)
  •  Sometime the startup may lack an R&D base
  •  Most entities lack adequate funds, and face a financial crunch
  •  Investments in the startup entities may sometime be illiquid
  •  Absence of comparable entities, since the kind of work, is novel and disruptive Startups are characterized by literally no past track record to fall back upon. Most startups make little or no revenue/ profits in the initial years and the future continues to remain uncertain. Given the existing scenario, the valuation of the business for any startup can be tricky.

When companies have a track record of operations, across sizes, valuation is fairly straightforward. When it comes to the valuation of publicly listed companies (that has steady revenues and earnings), a host of parameters are available at hand like earnings before interest, taxation, depreciation, and amortization (EBITDA) or based on other industry-specific parameters. The same approach cannot be applied to a Startup, making valuation complex and more intense.

Business valuation approaches for Startups

Investing in Startups involves a higher risk, owing to their inherent uncertainty in achieving future revenue potential. Luis Villa-Lobos and William H. (bill) says, “angle investors typically realize about 85% of their total returns from 15% of their total portfolio startup companies”.

You must look for the track record of promoters along with the fundamentals of business models and readiness of plans. Looking at all minute details is even more important when valuing an early-stage startup. A vast majority of startups go out of the business in the early stage itself. You must take a market approach while valuing a startup since there is limited proof of business and the financial projections could be too optimistic or speculative at times. The valuation must be revised with each round of financing.

Great ideas also do not make successful companies. A startup needs able mentoring and adequate funding at the initial stages in time. After each stage of funding, the valuation must be updated. The valuation considerations for a startup are typically different at each stage:

  • Stage 1; - Pre-revenue stage 
    The stage is characterized by virtually no or negligible revenues. The operation may not have commenced or commenced poorly. No meaningful conclusion can be drawn about revenue, cost, profits, and cash flow at this stage.
  • Stage 2:- Revenue generation commenced and gradually being scaled up 
    In this stage, most startups just start generating revenues and the scale of operation is at the base level. The revenues generated may still be small, but may offer valuable inputs for estimations when they gradually scale up.
  • Stage 3:- Post revenue stage 
    The revenue in this stage reaches a reasonably decent level and information about comparable transactions/operations may be available, though they need adjustments for computations.

Here are some of the prominent methods used for the valuation of the business for startups:

  •  Venture capital method or exit multiple method
  •  First Chicago method
  •  Scorecard method
  •  Berkus method

The Venture Capitalist/Exit Multiple Method

The approach is used by a venture capitalist who wants to stay invested over a period of 3 to 7 years and exit the company when certain milestones are reached. The approach estimates an exit multiple based on the post-money valuation. The exit price takes into account the time and risk associated with the investment.

Post money valuation =Terminal value /Expected ROI

OR

Expected ROI of investor = Terminal value/ post-money value

Chicago Method

The method is most commonly used for startups in the second stage. Using this approach, the valuation of a startup is done using the comparable companies multiples (which could be based on existing financial data or the exit year financial data).

The key advantage of this approach is that it combines the features of market-oriented methods and the fundamental analysis methods, for a better valuation. The step by step method involved is

  •   Create the future scenario of financial forecast at three levels to be more realistic,optimistic (best possible case), pessimistic(worst possible case) and balanced (average case). Here, different techniques of fundamental analysis are used. The method requires forecasting revenues, cause, and cash flows and the defined time frame keeping in mind the targeted exit period. The balance (midpoint) projection is computed post proper due diligence.
  •   Determine terminal value (a post which the investor plans to exit) for each of the three scenarios. Here market-oriented valuation concepts of multiples are used. The multiples could be related to key performance indicators such as EBITDA, revenues and more. The availability of transaction data concerning the peer group is critical for the computations.
  •   Determine the desired returns and calculate a valuation for each of the three scenarios.
  •   Estimate the probabilities for all the possible scenarios and calculate the weighted sum of the valuation to arrive at the final estimates.

The approach relies heavily on the availability of good quality data and statistical analytical techniques.

Scorecard Method

The base valuation is derived in a way similar to the Chicago method. Post that, the valuation is adjusted for a certain set of criteria’s impact on the overall success of the firm. The method is a very effective one since it gives due weightage to the qualitative aspects like company management, promoters track record, key competitors and the product/services as well. The method thus computes a weighted average value of the company based on multiple factors.

Berkus Method

Per the angel investor, Dave Berkus, the Berkus method, “assigns a number, a financial valuation, to each major element of risk faced by all young companies-after crediting the entrepreneur some basic value for the quality and potential of the idea itself.”

“Pre-revenue, I do not trust projection, even discounted projection”- Dave Berkus The method leverages both qualitative and quantitative critical factors to compute the valuation. The method uses five key elements:

  •   Sound idea (basic value)
  •   Prototype (reduces technology risk)
  •   Quality management team (reduces execution risk)
  •   Strategic relationships (reduces market risk)
  •   Product roll out or sales (reduces production risk)

A valuation can be challenging. You can avail the valuation services offered by The Filings, for exceptional quality and service.

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  • The scope of our services include:

    •  Business valuation
    •  Valuation of shares
    •  Valuation of tangible and intangible assets

     Timeline: The timelines depend on the requirements, and can be discussed on a case to case basis.

  • We take time to listen, understand and analyze your requirements

    The Filings expert is assigned based on your specific requirements

    Valuation work is done with utmost care

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    • We will need your inputs. We shall communicate the documents we need at the right point in time-based on the requirements.

    • Please write to us with your specific requirements. We will get back to you with a customized price quote.

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