Modeling & Valuation in a new space

In one of my recent interviews, the MD asked me "how would you do the valuation and modeling of a company/start-up where there are no reports, study, comparables or transactions? - it's a new space/area identified altogether. The entrepreneur will say many things, but being a banker, how would you approach to value the company? Assume the start-up has zero revenue"

How and where do we start? I mean no historicals, no comparables/transactions, no research reports, no size of the addressable market, ...

 

The easiest approach would be to simply identify companies in the same industry and determine at what multiple they trade relative to revenue. For example, assume you are able to identify 3 companies that are similar enough and they trade at an average of .8 * sales. Multiply your LFY (last fiscal year) or TMM (trailing twelve months) revenue for your company by .8.

 
Best Response
Stuckey:

I don't really have any experience in modeling startups and am wondering if there is anything in a DCF (NPV and IRR calc) that is required to be done to account for negative cash flows the first few years?

For example, say I have modeled out the cash flows and have the appropriate discount rate and the valuation came out to be $10mn. However, the first 2 years of the model forecast negative cash flows, assume ($1mn), that will require additional cash to be put into the business at the acquisition date. How should I be modeling that $1mn when I calculate an NPV or IRR?

I was thinking it would have no impact on an NPV calc, but in an IRR I would need to account for the $1mn somehow. With an NPV of $10mn would I adjust my purchase price down to $9mn and assume the $1mn is invested into the business? What other ways are there to account for this scenario?

Thanks,

Negative cashflows are completely normal in a DCF, there's no difference with a positive cash flow (just deduct it instead of adding, common sense). As for the IRR - check out the MIRR if your cashflows alternate from positive to negative, otherwise if all negative cashflows occur consecutively at the beginning of the project, standard IRR formula works just fine.

 

Believe it was Mark Cuban who commented that a top down approach for VC/start-up is bullshit because there's no tangible numbers to work with. The idea of even capturing a 0.1% marketshare could lead to "X" relies heavily on the assumption that your product has the competitive advantage, key success factors, resources etc to make "X" happen, which is nothing more than guessing on a whim.

I agree with you that "sales quote" is a pretty BS metric(which is why VC isn't on the top of my list), but when you're working with a startup, growth rates with clients/users or clients/sales person are the most suitable for this case.

 

Assuming that the company is cash flow positive you would use a DCF. You can almost always find comparable companies (given the subjective nature) so even if the company is not profitable you can use a multiple of revenue based on an industry or peer median/average. Alternatively, you could run a TAM analysis and try to determine what % of the market share the company may account for. Valuation is as much art as it is science so you can basically value anything.

 

Shorthand answers:

  • DCF (although there are limits to DCF and you could end up just doing a GGM-heavy valuation, which may as well be a multiples valuation)

  • Look at the EBITDA margins, historic and expected trends in revenue, EBITDA and capex, then look for companies with a similar profile, then apply the valuation multiples those "trajectory comps" trade at

Those who can, do. Those who can't, post threads about how to do it on WSO.
 

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