Early Stage Co. Cash Flow Valuation - Does it make sense?
Hi Everyone,
Essentially I am a junior at an VC shop where we invest in early stage companies often in series Seed to series B-C. As I got staffed on more deals, I realized my seniors always ask me to work out a cash flow valuation alongside trading comps/transaction comps/fundraising valuation, which I thought makes more sense. I raised this question to my seniors asking what's the rationale behind using a DCF valuation with extreme uncertainty on cash flows (discount rate we used can go as high as 50%). They told me it was to assess the valuation offer we got. But as I got placed on another new deal which the target doesn't even have its first sales, I got confused why they had asked me to model out the cash flows far in the future. Anybody could shed some lights on usual VC valuation approaches and the reasons why they might be so interested in looking at a cash flow projection? Thanks a lot!
I used to work in life science / physical science VC, so our approach was likely different than other industries.
We really only evaluated the strength of the science, the strength of the scientists / entrepreneurs (25-30% of new investments are with scientists we had invested in before), and potential market size ($1B+). This has been the partners' approach for the last few decades, and it has worked out pretty well thus far.
Granted we usually formed the company or invest pre-seed / seed, then follow-on in every other round until the IPO. Financial valuation at the early stages (even Series B / Series C) was definitely not feasible, especially if it's a therapeutics company that is years away from being able to sell their drug. I don't think it's really that important at the early stages but I am sure some seniors who like to see a tangible valuations appreciate it, regardless of its true value.
TLDR: Financial valuation can be a peace of mind for seniors; IMO early stage financial valuation is shooting in the dark; evaluate market size and comps
I can definitely relate to your experience at VC. I think else than the cash flow projections, we are basically taking a similar approach e.g. we focus a lot on how strong and reputable the scientific guys in the teams are.
Just a quick follow up question, if that’s the case, does it even make sense to put on my resume that I complied a DCF valuation blah blah blah? Would ppl just think I’m not understanding the industry or ppl will actually understand it’s because other seniors want that piece of work getting done regardless?
Yes put it, just be able to talk aboit a DCF and why Comps may be more appropriate.
Thanks! SB'ed.
As long as you can explain that it was for the seniors, but you understand that its usefulness is limited.
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