How do Venture Capitalists Value Companies?
What is the value of a company? That question comes up many times especi
ally
during mergers and acquisitions. Most venture capitalists value deals using an IRR hurdle rate or the minimum return they expect to receive in returns given risks of the new venture. Typically their goal is a potential IRR of at least 30%.
Let us look at five methods to value a company.
1. Price to Earnings ratio (P/E ratio): By using the P/E ratios of the industry we can value the company. For example, the medical device industry has a P/E ratio of 21-29 so given the earnings (or Net Income) we could calculate the price (offer to be made) to acquire the firm. If a medical device company had net income of 1.2M then taking 25 as the industry standard we can value the company at 1.2M*25= 30M.
2. Discounted Cash Flow (DCF): There are three methods to value a company using DCF as seen in the image. Its the main source of valuing a new venture as they are cash negative in the early years. Basically, you project the income for the first 6 years and discount it to the current year. You can forecast income in three ways - constant cash flow, constant growth and market multiple.
3. Price to Net Book ratio (PBR): This is is an indication of how much shareholders are paying for the net assets of a company. The book value is the difference between the balance sheet assets and balance sheet liabilities and is an estimation of the value if it were to be liquidated. When VCs want to buy companies they usually get all the financial statements from a company before making an offer. Thus, they have access to the balance sheets and the book value of the company. Based on their experience, the industry and the company, VCs usually have some expectations of the PBR. They use this data and the book value of the company to arrive at the price they want to offer for the company.
4. Price to Sales Ratio (PSR): This is based on the company's earnings or sales and does not consider debt and other liabilities. Again, there are industry standards for P/S ratio and if VCs know the sales of the company they can calculate the price they want to offer for the company.
5. EBITDA Multiple (Enterprise value /EBITDA): EBITBA is the earnings before interest, tax, depreciation, and amortization. This ratio measures the price (in the form of enterprise value) an investor pays for the benefit of the company's cash flow (in the form of EBITDA). An advantage of this valuation is that it is capital structure neutral, and, therefore, can be used for cross company valuations. VCs can get these numbers from the company's financial statements.
When to use which? Whichever method, brings you more money for your company. For example, companies that require big upfront investments or infrastructure (such as cable companies) and long gestation periods, EBITDA can be a more appropriate measure of the business's underlying profit potential since it excludes the cost of these investments so u=you would use the EBITDA multiple to value your company.
Three ways to calculate value of business at end of Year 6:
Method: Divide year 6 free cash flow by “k” cost of capital to value infinite earnings stream, then discount to present.
B. Constant Growth: Assume firm will continue to grow at constant percentage rate, with cash flow yield the same, to infinity.
Method: Multiply year 6 cash flow by 1+g (growth rate); divide that by
Kc – g (cost of capital less constant growth rate.) Discount to present.
C. Market Multiple: Assume firm could be sold at P/E multiple reflecting
year 6 earnings and growth rate.
Method: Apply industry average multiple to net income or EBITDA, tax effect proceeds, and discount to present.
Cool software and hardware for your iPad
Over the past few months I've been trying to find ways to use my iPad more like a regular laptop so that I can just use one device instead of two and the fact that it's so convenient. I still use my laptop but along the way I've found software and hardware for the iPad that's really amazing. Let's me show you this cool stuff with a few videos.
1. Keyboard: If you do a lot of typing a tactile keyboard definitely helps. There are a few on the market - Zaggmate is popular and expensive ($100) and Kensington is great value at $65. As seen in the video the keyboard comes in a case and is removable if you just want an iPad case. There are slots for the camera and to charge the iPad. You can also tilt it from 20-70 degrees for a better viewing angle. Volume and home controls are available on the keypad and setup is very easy.
2. Microsoft Office:OnLive, a company based in Palo Alto, has created OnLive Desktop a cloud based service for creating Microsoft Office (MS Word, MS Excel, Ms PowerPoint, etc.) files on the iPad. Files created on the iPad are accessible on any other device through the OnLive Files Website. They can be mailed and shared on a laptop but not on the iPad. To share the files that you created on the iPad you have to open the file on a laptop.
I'm waiting for the next version of the iPad when they (hopefully) have a USB or some form of external drive to help save files or at least have a file sharing option that is not limited to the Apple network.
|
Channel |
Value |
When to use? |
How to use? |
|
Social Media-Facebook |
Facebook friends are invested in helping you out so if you could ask them to share your message this channel will get you maximum reach |
If you want to create awareness and get maximum reach using your social equity. |
Ask friends to post your message and share with their network. In your message mention what you want and send the message with a link to your blog- don’t forget to track the link with bitly. |
|
Social Media-Twitter |
Gets you traffic but visitors will not spend quality time on your blog. It helps establish you in the Twitter world as a thought leader where you can communicate directly with other gurus in the field. It is also used to identify latest events, updates, etc in the field. |
Use twitter to become a thought leader as you will be judged on the quality of your tweets. You could tweet every time you write a blog post. You must tweet daily or every other day to stay current. |
Tweet regularly and often. Try to tweet original thoughts on topics in your field so that your followers will retweet it and thus your circle of influence grows to make you a thought leader in the field. |
|
Social Media-LinkedIn |
Very high value as people are looking to hire on this network and by using a blog you enhance its value. Visitors from this channel spent the maximum time on my blog. |
Always as you build your career – even when not looking for a job. To help give you a professional brand identity. |
Add the blog application to your linkedIn profile so that every time you post on your blog it appears on LinkedIn. Post LinkedIn status updates as and when possible. |
|
SEO – Content based on user interest |
This is the most valuable channel of all. If you don’t have a unique perspective that or interesting content visitors will not stay or revisit. This helps build loyalty and stickiness to your blog. |
Must always use content based on user interest else you will be one among the millions on dying blogs. |
With the help of many tools as mentioned above you can gauge user interest and write posts accordingly. I’ve also looked at the offline world (events, conferences) to gauge user interest in my field. |
|
SEO- Linking |
Social Media channels need regular effort but SEO is more of a long term strategy than Social Media. Efforts put in a year ago will still reap benefits. Linking helps get traffic from other similar blogs, directories and is one of the easiest SEO methods. |
Use only when you are linking to sources that add value to your blog otherwise people will realize you are just spamming their pages/websites/blogs. |
Check the credibility of the places you link with as they can either help you or even harm you. Page ranks of above 6/10 or higher are good to link to. |
|
SEO-Long tail keywords |
Helps differentiate you from competitors by targeting a niche within your field (example:marketing+ technology+healthcare) |
Must use to win against the bigger competitors in your field as you won’t win competing head to head (like Judo Strategy). |
Use the traffic estimator to see which combination of keywords keep increasing in traffic month over month |
|
SEO tools- plugin |
Tools help to make it easier for Google’s search bots to find the right keywords and thus increase SEO. |
For every post use the SEO plugin to promote your keywords |
WordPress (blog platform) has a number of SEO plugins that can be added easily. |
|
SEO-keywords |
Since the entire SEO game is about keywords it is critical to get the best value by choosing the most valuable keywords |
Use to understand trends in the industry and what people are looking for so that content on blog can be tailored accordingly |
Use keyword tools to identify these keywords as well as what keywords the competition is targeting |
|
Adwords |
Ads help reach a wider audience as well as create awareness. Adwords is the most targeted form of traffic. |
When you have the budget to reach a wider audience and when you feel the ROI is worth it |
There are some best practices mentioned above (categorize campaigns, use more than 1 ad, bid accordingly and write effective ads) but I still need to learn how to best use this channel |
