What's the average discount rate for a early-stage technology company?
IB
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on 8/16/12 at 12:52pm
My bank works with very early stage companies, and I'm currently looking through some of the models and trying to understand them. WACC is calculated to be ~9% using beta derived by doing comps on capIQ. It looks like we then applied a 80% "liquidity and size" premium. This seems insanely high for me. A 89% discount rate? Is this normal when valuing early stage companies? And if so, how does one figure out how much of a premium/discount to apply?





Honestly, it's high, but it's
Honestly, it's high, but it's not as crazy as you think.
These companies are relying largely on equity, which is more expensive. And they are undeveloped, which means uncertainty, which means selling equity is expensive. Think about it: some high growth, early stage "disruptive" tech startup needs $100,000. This company has huge potential future growth, but really needs this funding. They settle on a valuation of $2mm, and the VC takes a 40% stake for his $100,000. In 9 months, the company is worth $8mm. Sucks to suck, but start-ups are an uncertain business, and nobody is going to give you a deal.
Conceptually, cost of equity = risk free rate + risk premium. Start-ups fail frequently. Early investors expect to (and are) compensated handsomely for the risk they take.
"There are three ways to make a living in this business: be first, be smarter, or cheat."
I guess that makes sense. I'm
I guess that makes sense. I'm having trouble understanding how these valuations aren't complete bullshit still. Even with a 90% discount, enterprise value is over $60MM for a company with two years of projected negative FCF. And somehow they have managed to raise over $10MM already.
The long term growth rate also seems high/has an obviously significant affect on enterprise value. I know that for most normal companies long term growth would be around the rate GDP is growing at. Do early stage tech companies have much higher growth rates too?
arguewithatree: I guess that
I guess that makes sense. I'm having trouble understanding how these valuations aren't complete bullshit still. Even with a 90% discount, enterprise value is over $60MM for a company with two years of projected negative FCF. And somehow they have managed to raise over $10MM already.
The long term growth rate also seems high/has an obviously significant affect on enterprise value. I know that for most normal companies long term growth would be around the rate GDP is growing at. Do early stage tech companies have much higher growth rates too?
Yes. You'll probably want to use a multi-stage growth model, which assumes different growth rates over time. A good resource: http://pages.stern.nyu.edu/~adamodar/
"There are three ways to make a living in this business: be first, be smarter, or cheat."
arguewithatree: I guess that
I guess that makes sense. I'm having trouble understanding how these valuations aren't complete bullshit still. Even with a 90% discount, enterprise value is over $60MM for a company with two years of projected negative FCF. And somehow they have managed to raise over $10MM already.
The long term growth rate also seems high/has an obviously significant affect on enterprise value. I know that for most normal companies long term growth would be around the rate GDP is growing at. Do early stage tech companies have much higher growth rates too?
Yes. You'll probably want to use a multi-stage growth model, which assumes different growth rates over time. A good resource: http://pages.stern.nyu.edu/~adamodar/
"There are three ways to make a living in this business: be first, be smarter, or cheat."
Okay thanks for the help. Yes
Okay thanks for the help. Yes it is a multi-stage DCF I'm looking at. How does the banker go about identifying the premium to apply?