VALUING STARTUP VENTURES

As accounting principles (GAAP) in USA point out, there are three key methods used for startups’ valuations. Except for presenting them,
I’d especially like to emphasize their relevance to the Polish ecosystem.

Startup valuations methods

Among three mentioned methods, the first one is based on the last transaction. Meaning, the value of a company equals the last financial round realized within the past 18 months. This approach’s main assumption is built around the rationality of the previous round’s professional investor (providing that he acquired at least 5% of a company). Considering the valuation was established at a certain level, all shares in a given startup should be reevaluated to this level.

The second method is a comparative one that assumes to estimate a startup’s value based on the value of comparative companies (comparable products, markets, size and the stage of growth). This method is especially relevant when dealing with a later-stage startup that can be put in contrast to publicly listed companies.

The third method is the one that is currently gaining recognition in Silicon Valley and becoming more popular, namely Option Pricing Model (OPM). Using this method, the valuation is based on different company’s development scenarios as well as each scenario’s success probability. In the US environment, it’s also connected to the price modeling with reference to the shares’ classes.

Polish financial environment’s specificity

Funds incorporated in Poland are operating under the supervision of the Polish financial market regulator, namely KNF (Polish Financial Supervision Authority). They operate as either the Alternative Investment Company (ASI) or the Non-Public Assets Investment Fund (FIZAN), that determines startups’ reporting obligations. On the other hand, KNF requires periodic valuation of the portfolio to bring it as close to the market value as possible. This approach is designed to protect LPs from being “misled” about the value of the funds’ assets.

Referring to the spectacular example of the GetBack collapse — the regulator’s aim is to prevent the assets’ value overestimation (in GetBack case there were packages of overdue payments). The distortion of historical investments’ results help to keep the good reputation of a financial institution and then make the fundraising easier.

In the case of funds operating as FIZAN, the supervisor requires the assets’ valuation being periodically done by an independent, specialized entity. And up to this point, this approach sounds reasonable, but in practice there’s actually a lack of valuation standards dedicated to early-stage technological companies.

Technological companies’ valuation methods

Some of the most common methods are valuations based on fixed assets or income. The first one significantly lowers companies’ value as it’s being mainly based on the team’s know-how and competencies. The income-based methods are much better to reflect the business potential, and still the most popular method here is DCF (discounted cash flow). It assumes that a given venture is worth as much as the cash flows it generates during the forecast period, discounted by different risks and market indicators, such as “lack of liquidity” or floating money value over time. It’s being a reliable and internationally recognized method for later-stage companies that already have detailed historical data that enable to not only better analyze the costs structure, but also predict market demand and the related revenue growth rate.

The value of such an approach for young, innovative companies is rather uncertain and limited. Let’s take a biotechnology company working on innovative vaccines — during the 5 years forecast period it will most likely not have any revenues yet (no cash flow), because it is not able to launch the product within that time. Does it mean this company is worth nothing? Even if the forecasted period will be extended, the credibility of such a methodt is highly questionable.

SpeedUp Group valuations’ approach

The portfolio company is booked at a so-called post-money valuation — it’s worth as much as we paid for it. When a given company realizes the new transaction, we update the value of our shares to the level of that round’s post-money valuation (that might be both an appreciation or a value decrease).

In case there’s no such a transaction within 18–24 months, we update the value of a given asset ourselves. As we know our portfolio companies quite well and they are usually not at the early-stage anymore, we blend DCF valuation with a comparative one, assigning weights to each method.

We believe that this approach is the best one to most precisely reflect our portfolio value.

Investments’ exits

First of all, it’s crucial to keep in mind that VC funds’ main goal when acquiring shares or stocks is to sell them later on and make profit out of it. Our shares can be perceived as products that we make trade with. The VC funds’ investment perspective is around 5–10 years, it rarely happens to be longer. So when an entrepreneur decides to get an investor on board, he needs to be aware that in fact he opens his company to new investors in the future.

Practically, there are four most common exit methods (that’s of course
an generalization):

• industry investor sale — a big market player that has the means to consolidate the market buys the shares in most often smaller company. Such an investor usually expects to acquire 100% of shares that means the necessity for the founders to sell their shares as well,
• financial investor sale (it’s usually Private Equity fund) — similarly to the previous case, financial investor most likely wants to acquire 100% of a company or at least most of it,
• IPO — public offering means for the founders the possibility to keep their shares. It’s the VC fund that is being replaced by the stock investors,
• management buyout — happens when the founders acquire the fund’s shares using their own capital and very often cooperating with buyout funds specialized in such transactions.

Considering the variety of valuation methods and different startups development stages, there’s no a common valuation standard being adopted by investors. The earlier the company is the harder it is to value it accurately and there’s a reason for saying that startup valuation is more of an art than a science. Hopefully, above mentioned approaches can make this art a bit of the scientific one.

If you have any questions or feedback to the article or if you would like to discuss the potential investment cooperation, please reach out to us via apply@speedupgroup.com. We’re looking forward to talking with you!