clues to .com valuations
Valuing a startup company has always seemed a
mystery for startups companies now made doubly arcane for companies in
the revolutionary, hyper-competitive Internet space. What's the
secret? At this Morino Institute Netpreneur Program Coffee &
DoughNets meeting held December 15, 1999, netpreneurs got clues from
four expert perspectives: an investment banker, a valuations analyst,
a venture capitalist and an entrepreneur who recently went through the
first funding process.
made at Netpreneur events and recorded here reflect solely the views
of the speakers and have not been reviewed or researched for
accuracy or truthfulness. These statements in no way reflect the
opinions or beliefs of the Morino Institute, Netpreneur.org or any
of their affiliates, agents, officers or directors. The archive
pages are provided "as is" and your use is at your own
Copyright © 1999, Morino Institute. All rights reserved. Edited for
length and clarity.
fran witzel: introduction
Good morning. I'm Fran Witzel, vice
president of the Netpreneur Program.
If the 600+ registrations for today's
300 seats is any indication, valuation appears to be a popular subject
among netpreneurs. Although we only have time to barely scratch the
surface, we hope you will find this an informative and
thought-provoking introduction to this challenging and important
subject. Beyond what we cover here, you may also want to visit Bond
& Pecaro's Cybervaluation
report, VentureOne's Customized
Valuation reports, FairShare.com's Valuation
Calculators and Fran's
Funding Resources for more information.
Hooke of investment banker Hooke Associates, our first speaker and
our moderator, will present some basic concepts on company valuation,
after which we will hear different perspectives from Jeffrey
Anderson, valuation expert with Bond
& Pecaro; Scott
Frederick, a venture capitalist (VC) with FBR
Technology Venture Partners; and Angie
Kim, a netpreneur who is president and chief customer officer of EqualFooting.com.
We'll then open it up to the floor, taking your questions, as well as
those that have come in by email.
We are truly fortunate to have a great lineup of
speakers, starting with Jeff Hooke.
jeff hooke: the investment
It's very nice to be here. Clearly, there is a
great deal of interest in Internet valuation and, with this group of
experts, I don't think we'll be disappointed.
So, let's start with how you value a company in
a general way. I always like to tell people that valuation is not like
physics where you can duplicate results by dropping a ball and
measuring how many seconds it takes to fall. Valuation is not a
science at all. It does, however, give you a methodology to derive a
rational justification for why you should make a purchase or a sale of
stock or of a company. This rational concept, however, is often
clouded by herd psychology, emotion or just poor logic.
When you boil it down, there are
basically two methods for valuing a stock. The first method is the Discounted
Cash Flow (DCF) method. For those of you who have taken a business
school course, that's the method you usually learn about. The second
method is the one that's far more popular on Wall Street and in the
real world, the Relative Value method, which looks at comparable
companies and transactions.
Let's go over a quick example of a DCF
calculation for an Internet company in today's world. Say the company
is losing money in 1999, as many of them are, and it's forecasted to
lose money for the next five years, finally making money in 2004.
Using the DCF method (Figure
1), you would assume there are no dividends paid over
that five-year period, so there is no dividend cash flow to project.
For 2004, however, you apply standard earnings multipliers, either P/E
ratio or EBITDA
ratio. You now have a big number projected out in the future, and
you discount that value to the present. If the company was Proctor
& Gamble or General Motors, you might use a discount rate of 15%.
Since Internet companies are more speculative, the discount
rate should be 30% or 40%. If you apply that kind of discount rate to
a company that is theoretically worth $100 million in the year 2004,
it would be worth $27 million today.
What about the Relative Value Method? Relative
value involves taking the value multiples (such as P/E or EBITDA) of
publicly traded firms, M&A deals or VC financings and calculating
fundamentals to come up with a table of multiples that can be applied
to the firm in question. This method is most effective with companies
that have positive earnings or EBITDA, but it's not a great a method
for companies that show losses. It's a little bit like real estate
valuation. If you are looking to buy a four-bedroom home in McLean,
Virginia, you look at comparable sales, including how the last three
similar houses traded in McLean. For companies, you would look at four
or five similar firms or deals, then apply the multiples to your
If a firm is losing money and doesn't have an
P/E ratio or EBITDA, it will typically find multiples of operating
statistics. For example, enterprise value divided by number of
eyeballs hitting the site, or divided by sales or number of employees.
This is not new. People sometimes think so, but it's been done before
with cable TV companies in their infancy. They were valued on numbers
of customers or sales. Cellular phone companies would calculate value,
based on the number of persons covered in their license area.
For companies that are past the startup phase,
another alternative is to look at publicly-traded companies and VC
deals, and apply the kind of ratios I mentioned such as price/sales,
price/visits or price/employees. For companies that are still in the
startup phase, VC firms and strategic investors like to use a
combination of DCF, comparables based on projected value and similar
VC deals. They might, for example, project that a certain company will
have sales of $10 million four years from now. Companies are trading
at 5x sales, so the company three years from now might have a value of
$50 million—take it back to the future. They might also look at
comparable VC deals that have taken place with similar businesses,
although sometimes that can be hard to find. There are also a number
of VC rules of thumb. For a "concept company" that has no
real track record whatsoever, a rule of thumb might be $1 million for
20% of the ownership.
jeffrey anderson: the
Good morning. Fran gave us the challenging test
of covering the topic of valuation of Internet companies in five
minutes or less. I had hoped that one of you entrepreneurs in the
audience would have developed a Web site that would provided us with
instant valuation for these companies—one where you could plug in
the name of the company, its brand and the total cups of coffee
consumed by each employee per day. I'm sure that those variables are
closely correlated with success.
Although there are no magic formulas for valuing
Internet companies, the good news is that there have been several
hundred IPOs this year. This has provided us an opportunity to take a
look at the financials and operation of many new, emerging growth
companies. Jeff did a great job summarizing the methods available to
assess value in companies today. We find it useful to look at as many
of these tools as possible.
I'd like to share with you my thoughts in three
areas: the market approach, income approach and the importance of
intangible asset valuation as it relates to Internet companies.
The market approach analyzes recent sales
transactions of businesses. In a recent study, we set out to
illustrate the marketplace range of valuation multiples for Internet
companies. As Jeff mentioned, the valuation multiple is simply a ratio
or measure used to compare the relative values of businesses. We
examined over 550 transactions involving Internet-related sales this
year through the third quarter of 1999. These include IPOs, mergers
and asset and stock sales. We then separated each transaction into
four very broad categories: Internet service providers (ISP), portals,
Internet retailers and business-to-business (B2B) ventures. As you can
imagine, categorization of these companies is very difficult. The
industry is changing quickly and many of the companies rated in
The calculation of valuation multiples was based
upon a two-step process. First, we computed the enterprise value. In
the case of asset sales, for 100% of the assets that were purchased,
we used a purchase price paid for those assets as the enterprise
value. In the case of stock sales or IPOs, we started with market
capitalization of those companies at that time, added long-term debt
and deducted working capital to get the enterprise value in those
Next, the enterprise value was divided
by an appropriate metric. As Jeff mentioned, commonplace metrics may
include revenues—either trailing revenues or year ahead projected
revenues. Operating metrics may include subscribers, registered users,
customers or monthly visitors, among many others. As expected (Figure
2), the multiples in all segments varied quite widely.
The multiples in the charts are based upon trailing revenues. We next
computed a weighted average for each full set of data in each segment.
We analyzed the data for outliers and atypical transactions in order
to determine a broad range of multiples (Figure
3). You can see that the variables were quite large, both
between segments and among companies within each segment. It's
interesting to note that the weighted average multiple by subscriber
in the ISP sector is in the $1000-$2000 per subscriber range, which
contrasts with recent sales of cable TV systems, many of which have
traded in the $4000-$5000 range.
There are three things to keep in mind when
looking at this data. First, like any broad averages, they are just
starting points for relative valuation. The operating metrics, whether
you consider revenues, subscribers or anything else, are only potential
indications of value. Ultimately, the value is equated with discounted
cash flows that companies hope to achieve. Second, it's very important
to be careful in selecting comparables. We try to look at companies
that are similar in terms of structure, market position and size to
those companies we are analyzing. Third, the multiples appear high on
an absolute basis, but remember that these companies are growing at
100%, 200%, 300% in revenues per year. These multiples will be
dropping quite rapidly in the next few years.
We regard the income approach as a primary
method. It is extremely difficult with valuations as high as they are
today to apply the discount and income approach to these companies;
nonetheless, if you haven't tried, you really have to sit down and
take a look at the revenues—hopefully the operating profits for two,
three, five years out and for the long term. Even though it's
difficult to predict what next year's revenues are going to be, in
order to sustain these huge values, it's incumbent upon the operators
and owners to look at the company in terms of getting to the steady
Very quickly, I'd like to touch on
intangible asset valuation. If you take the purchase price paid for
some of these companies and deduct the fixed assets, you are left with
a huge value to allocate, probably 90% or more that is attributable to
their intangible assets. The reason it's important is that many
Internet companies, both new media and traditional companies, have
been using intangible assets as a form of currency. A good example is CBS
which traded advertising promotion dollars for an equity stake in Sportsline
USA. There are many other examples that have occurred this year.
Online companies also are shifting some of their assets to other
companies as a form of currency. Take, for example, the opportunity in
the media sector with broadband media developing so rapidly. Many of
these new media companies have a great chance to monetize some of
their valuable intangibles. These include content in the form of
programming, audio/video archives, sports information and data.
Customer assets include subscribers, audience bases, marketing in the
form of promotion and unique distribution channels. It's possible to
value these assets, for example, in a situation where a company might
contribute banner ad space for a two-year period. You might consider
the foregone opportunity of giving up the space. Could you have sold
it? What are the implications of giving up the space for two years?
Alternatively, from an income approach, what are the incremental
revenues or operating profits that could have been derived if that
space had not been contributed to a joint venture, marketing agreement
or a new company. Take a close look at these intangibles, not just as
a way to generate or monetize the revenues, but also as a form of
currency for partnerships, joint venture or in raising equity.
scott frederick: the
Good morning. Jeff and Jeffrey have done a very
good job of laying out what happens in the public markets. Now I want
to try to explain what happens at a much earlier stage in a company's
I want to walk through some dos and don'ts
in attempting to establish the valuation of a venture capital stage
company, then conclude by taking you through our methodology—although
I'm not even sure that's the right word for it. Let me start with the
don'ts because they are easier.
The first thing is: don't work backward
from the valuation or the market cap of a "gorilla," such as
an America Online, Cisco
when trying to estimate what your rate of return is going to be. It's
going to hurt you for two reasons. First, it's not going to be
productive at all in determining the proper valuation for an early
stage company. It ignores the private liquidity discount, as well as
the fact that a large portion of the risk has already been beaten out
of the gorilla. Remember, value is a function of the magnitude, timing
and risk of future earnings. Hopefully, you heard that
accent on the word risk. In addition, it ignores the fact that the
gorilla's current valuation may not be sustainable. More importantly,
doing so actually could hurt you in getting financing. We see about
1500 to 2000 business plans a year. If we see a plan that has an
unrealistic valuation expectation in it, we have to take that into
consideration when deciding how to allocate our time. Regardless of
how great or compelling the business idea, we have to ask ourselves
whether or not we want to bring you in if we think we're going to have
to wrestle with you for a few weeks about valuation?
Another concept that I think is relevant is the
concept of increasing returns. Success is nonlinear. Once a
"gorilla" reaches a tipping point or critical mass, it's off
to the races. Success breeds success and their valuations rise
exponentially. Most of the companies we value have not yet reached
that point, so they can't justify similar valuation multiples.
The second thing I urge upon you is:
don't minimize short-term dilution at the expense of long-term
dilution. Let me give you three examples straight from our portfolio—LifeMinders,
and Silicon Wireless. We financed two of those companies at single
digit pre-money valuations and one at a valuation of over $100 million
pre-money. Two are going to be successful IPOs—one is already public
and the other is going out very, very soon. The third is bankrupt.
There is a lesson in that. The company we funded at the very high
valuation tried to toe the line on dilution. They put themselves in a
position where they had nowhere to go on subsequent financings. The
other two companies realized that they had to get money quickly to
build a business, and they did just that. Was the valuation right in
single digits? It's going to work out great for us and it's certainly
going to work out great for everybody on the management teams. There
has been a lot of wealth created in those companies.
If I can get across one message, it's to look at
a financing round not in isolation, but over the lifecycle of your
company. Your goal is to go public or to have some sort of exit, I
presume. If not, you are probably not appropriate for venture capital.
If that is your goal, look at the sum total effect of dilution on your
path to liquidity, not just the dilution you are going to suffer in
your initial round of financing.
So, what are the dos? My time is limited,
but, first, I urge you to make sure you understand VC-speak. We work
in this field every day, so we tend to think that everybody knows what
we are talking about when we use terms like pre- or post-money
valuations, but it's not always intuitive. One term you will hear a
lot is fully diluted pre-money.
Second, make sure that when you compare
alternative ways to finance your business that you are comparing
apples to apples. What do we mean when we say fully diluted
pre-money? Why do we even use that term? We use it because it's
the easiest way to give an indication of what valuation range we are
coming in at—e.g. $10 million pre-money versus $50 million
pre-money. But when a VC speaks of a pre-money valuation, he or she
generally is speaking of a fully-diluted pre-money valuation.
This means that they are going to include in the calculation all the
options and any warrants. We all basically include anything that can
turn into common stock at the end of the transaction.
Page one of
four | Next page