1.
Attractive market/industry
How to assess if a market is
attractive?
|
Characteristics of an
attractive market
|
Market size
|
Large market with
many potential customers
|
Market rate of
growth
|
High growth markets help businesses to
grow revenues and are often positively correlated with profitability
|
Demographic,
lifestyle or other trends
|
Trends which support
the growth of the market
|
Regulations
|
Low regulation (but note regulation
can also be a positive factor)
|
Impact of
technology on the market
|
Market supported by
technology trends (Sustaining vs. disruptive innovations)
|
Porter’s five
forces
|
Generally low level of forces
(customer bargaining power, supplier bargaining power, threat of substitutes,
threat of new entrants and intensity of rivalry)
|
2.
Attractive business model
How to assess if a business
model is attractive?
|
Characteristics of an
attractive business model
|
Market
position/competitive advantage
|
Defensive market
position with clear competitive advantages. Potential for market leadership
|
Sustainability –
Barriers to replication
|
Strong barriers to replication
|
Financial
characteristics
|
Strong cash flow and
working capital characteristics
|
3.
Experienced and entrepreneurial management team
How to assess if a management
team is suitable?
|
Characteristics of a suitable
management team
|
Experience and
suitability
|
Business and
technical experience to deliver on business plan
|
Entrepreneurial
track record
|
Serial entrepreneurs or first time
entrepreneurs with strong credentials
|
Appropriate
alignment of interest
|
“Skin in the game”
(E.g. significant shareholding in business, performance-based compensation)
|
· Are serial entrepreneurs more likely to succeed
than first-time entrepreneurs?
o
First time entrepreneurs:
Driven by a personal passion
Can be obsessive and stubborn
May struggle to build a company around the
product
o
Serial entrepreneurs
Experienced at building and running a company
May not be driven by a personal passion
May suffer from the “second album effect” (E.g.
Puff Daddy)
o
There’s no difference, however industry
experiences helps
4. Attractive valuation/returns potential
·
Methods to value a company?
1. NPV of discounted CFs (DCF): details way to look at a company, building a company in an excel model
1. NPV of discounted CFs (DCF): details way to look at a company, building a company in an excel model
Advantages
|
Disadvantages
|
Because DCF are so details, startups
usually lose money and eventually it will make money – with a 10 year DCF a
company can look at when will the company break-even (Make money)
|
It is really the
product of your input – if put garbage into the DCF and garbage is going to
be coming out
|
Sensitivity
|
Hard to predict short term for a
startups so it will challenging to forecast the future
|
Good for infrastructure such as toll roads (where
you have 20-30 years period and the owner is entitled to all the tolls that
come to them – can be roughly valued)
|
|
Useful for resource companies (determining
the amount of gold an metal and a certain percentage that can be extracted
and the resources won’t last forever, so DCF can be used)
|
2. Option methods: takes uncertainty into account
Advantages
|
Disadvantages
|
Can take uncertainty into account which you
can’t explicitly with the other methods
|
Not really used in a
particle investment world and it is really hard to explain to a startup
founder
|
3. Multiples: standardized the value of a dollar – compare companies across the industries (easiest method for startups always)
Enterprise value/EBITDA (a negative value)
Price/Earnings (P/E) (also a negative ratio)
Enterprise value/Revenue (Mainly use this to
value because startups earnings are generally negative so we don’t want to add
more negative value to earnings)
·
VC valuation – Pre-money and Post-money:
o
Companies raise VC funding through issuing new
shares to VC firm
o
Funding occurs in “funding rounds” (E.g. Round
A, Round B, Round C; or Series A, Series B …)
o
Each funding rounds has a pre-money and a
post-money valuation:
a)
Post-money valuation = the value of the company
after the funding round
(# of existing shares + # newly
issued shares) * share price of funding round
b)
Pre-money valuation = the value of the company
before the funding round
Post-money
valuation – funding amount
o
Example 1: If a company has a pre-money
valuation of $5million, and raises $3million in VC funding, it has a post-money
valuation of $8million.
o
Example 2: Wizztech.com currently has 100, 000
shares on issue. It is seeking a raise $2.25 million in new VC funding at $150
per share in a series A funding round.
I.
How many new shares will Wizztech.com be
issuing?
=$2.25m/$150 = 15, 000 new shares
II.
What % of ownership will the VC firm have in
Wizztech.com?
= 15, 000/(100, 000 + 15, 000) = 13.4%
III.
What is Wizztech.com’s series A post-money
valuation?
= (100, 000 + 15, 000)*150 = $17, 250, 000
IV.
What is Wizztech.com’s series A pre-money
valuation?
=$17, 250, 000 - $2, 250, 000 = $15, 000, 000
5. Clear exit path
·
VCs often look to sell their shareholding in a
portfolio company within three to seven years
·
Exit timing may be driven by the requirements of
the VC fund – many funds are 10 years closed-end funds
·
Exit options:
a)
IPO *
b)
Trade Sale/Merger *
c)
Wind-up/Liquidation (last resort)