Business Valuation Services

Business Valuation for Capital Raising

You’ve reeled the investors in. You’ve wowed them with your unique vision and strategy. You’ve established that the target market is massive, and that you know exactly how to secure a big chunk of it. You’ve convinced them that you’re the right horse to bet on. They’re itching to get a piece of the action. But before writing the check, they need to know:

• How much money will the company make?
• How much outside investment is needed, and when?
• How much of the company do the investors get?

All three questions are inseparable from the million (or billion) dollar question: How much is the company worth? In other words, what is the valuation?

By providing an answer to that critical question, clearly communicating the methodologies and logic used in reaching your conclusion, you are in a far stronger negotiating position with potential investors.

Show them the money: It all starts with the financial model

Investors are in it for the money – specifically, the future cash flows. So, before buying in, investors must assess the magnitude and timing of those cash flows. You, the entrepreneur, must show them the money (well, the potential money, anyway). How? With a robust, user-friendly financial model.

Cash flows are a function of many factors:

• Revenues: Money received from customers in exchange for goods and services
• Expenses: Money paid for product inputs, employees, supplies, leases, research & development, interest, taxes, and anything else needed to produce goods and services
• Capital expenditures: Money invested in long-term assets – factories, trucks, machinery, servers – needed to produce goods and services
• Working capital: Money tied up in short-term assets – inventory, accounts receivable, petty cash – needed for operations; money accrued – accounts payable, taxes payable – by deferring payment to suppliers and other payees
• Non-cash items: Depreciation and amortization of long-term assets
• Debt: Money borrowed from, and repaid to, banks and other lenders

Sound complicated? It can certainly get that way. That’s where a robust, user-friendly financial model comes in. A financial model is a custom-built spreadsheet that takes all relevant inputs specific to the business, performs calculations specific to the business’s unique economics, and generates outputs critical to assessing the business’s potential. Key outputs of a good financial model include:

• Financial projections (“proformas”): Standard accounting statements: income statement, balance sheet, cash flow statement
• Funding needs: Projection of how much outside investment is needed, and when
• Net cash flow to equity: Projection of how much cash will be returned to investors, after consideration of all cash inflows and outflows

A robust, user-friendly financial model that clearly and logically shows the mechanics of how you make money demonstrates that you’ve done your homework, putting you in a stronger negotiating position with prospective investors.

From the financial model comes the business valuation

Once you’ve shown them the money – the future cash flows – it’s time to show what that money is worth today – the valuation of the business. (Side note: Many people search online for “business evaluation services” when what they are really looking for is “business valuation services” or “business valuations.” This is a very common mistake!) To determine what percentage of the company investors should receive for a given amount of capital, one must first estimate how much the entire company is worth. Let’s say the financial model indicates that $2 million in outside investment is needed. If the company is worth $10 million, investors get 20%; if it’s worth $5 million, they get 40%.

There are many valuation methodologies, but fundamentally, any income-producing asset – a business, a rental property, a patent – is worth precisely the present value of all future cash flows accruing to its investors – its owners. The present value of any cash flow is the amount that an investor is willing to pay today for the potential of receiving that particular cash flow in the future. Present value is always less than future value since investors must be compensated for inflation, delayed consumption, and the risk that the payoff will not occur as projected. How much less depends on market and economic conditions and the degree of uncertainty surrounding whether projected cash flows will materialize.

Business Valuation for Strategic Planning

Value creation is the goal of any entrepreneur. Whether investors realize their payoff in the form of dividends, sale of the company, or initial public offering, maximizing the present value of future cash flows – maximizing the valuation of the business – is the ultimate objective. Any strategic initiative under consideration – a new product line, geographical market, marketing campaign – must be assessed based on how much value is added to the business.

As with capital raising, it all starts with the financial model – a robust, user-friendly financial model is an indispensable tool for strategic planning. Users can test different scenarios, adjust inputs, and activate/deactivate strategic initiatives under consideration, instantly seeing the effect on projected cash flows, funding needs, and valuation. Through that iterative process, decision-makers identify courses of action that optimize financial performance, allocation of funding resources, and, ultimately, valuation.

Startup Valuation: A Distinct Flavor of Business Valuation

Startup valuations are based on the same principles and theory as other business valuations. However, because there is generally less information available, and more risk involved, startup valuation consulting requires a specialized set of skills and methodologies.

The unique set of challenges notwithstanding, developing a startup valuation is a highly worthwhile exercise. Armed with a logical, clearly explained valuation analysis driven by a robust, user-friendly financial model with well-researched assumptions, you are in a far stronger position when negotiating with prospective investors.

Startup valuation: How is that even possible when there are no earnings?

A common misconception is that business valuation services can be performed only for mature, established companies with a meaningful history of generating revenue, net income, and cash flow. Startup valuation services are not possible, the logic goes, because there is little or no financial track record on which to base a startup valuation.

In fact, a business’s value is based on the cash flows expected to come in the future, not the cash flows that have already come in. The past is history – it has already happened! The cash flows of the past – positive and negative – have already been realized by the existing shareholders – owners – of the business. What the new buyer of the equity acquires is ownership of the cash flows to be generated starting from the time of purchase – the future cash flows.

That goes for any business, large or small, mature or early stage. When buying 100 shares of an S&P 500 company on the open market, the investor gains a claim on a minute percentage of the company’s future cash flows; the benefits of past cash flows have already been realized by the seller and any previous owners of those 100 shares, in the form of dividend payouts and/or price appreciation. Does that mean that the buyer of a publicly traded stock should simply ignore the company’s past financial performance? Of course not. Historical financials are useful insofar as they demonstrate a company’s ability to generate cash flows. Past financial performance serves as a meaningful indicator of management capabilities, market acceptance of the company’s products and services, industry conditions, and any other factors that affect the company’s potential for generating cash flows in the future.

How, then, does the investor in an early-stage venture gauge future financial potential when historical financials are scant or nonexistent? Very carefully. There is, quite simply, far less information available for startup valuations than for business valuations involving mature companies with significant financial track records. The startup valuation process must take into consideration many more uncertain factors than the business valuation process for established companies. Without the luxury of historical financials, the startup valuation analyst is forced to rely primarily on far more ambiguous, intangible attributes, such as management ability, expected desirability of products and services, and technological advantage.

Startup valuation: How is that even possible when there are no assets?

Another common misconception is that the value of a business equals the sum of the values of all assets owned. That includes tangible assets, such as factories, machinery, trucks, inventory, cash, and accounts receivable. It also includes intangible assets and intellectual property (IP), such as patents, trademarks, and proprietary technologies and processes. Since the assets of a startup are negligible, the logic goes, there is no way to come up with a startup valuation.

In fact, what individual assets, as standalone items, are worth is largely irrelevant when assessing the fair market value (FMV) of an operating business. Any business consists of a unique combination of assets, tangible and intangible. That specific set of assets, configured in its own distinct way, is precisely what enables the company to generate revenue, earnings, and cash flow. Unless those assets are to be separated and sold off piecemeal, rather than used to generate cash flows for the business, there is little reason to value them individually – their collective value is reflected in the cash flows that they enable the company to generate.

Early-stage companies are made up primarily of intangible assets, including management capability, workforce expertise, corporate culture, patents, trademarks, and proprietary technologies and processes. Unlike hard assets, such as factories, machinery, and inventory, intangibles are notoriously hard to value. The good news is, intangible assets, like tangible assets, are valuable only insofar as they enable the company to generate cash flow. The value of all assets, therefore, is fully reflected in the projected cash flows. As with all business valuation, the startup valuation process takes the projected cash flows and translates them, using various methodologies, into the current fair market value (FMV) of the business.

Where Cayenne Comes In

Cayenne Consulting provides business valuation consulting, startup valuation consulting, and financial modeling services to help position ventures for successful capital raising negotiations and effective strategic planning.

Negotiation is central to capital raising. Buyers and sellers of equity – investors and entrepreneurs – differ on financial assumptions, such as projected units, pricing, cost of goods sold, staffing, long-term assets, working capital, and required rate of return. Any change in assumptions affects valuation. Cayenne focuses on developing financial models, valuation analyses, and startup valuations to serve as negotiation tools, helping ventures approach investor discussions from a position of strength. Quite simply, a logical, clearly explained valuation analysis based on a robust, user-friendly financial model with well-researched assumptions puts you in a far stronger negotiating position with prospective investors.

An independent, third-party valuation opinion is generally not necessary for raising capital, particularly in the startup stage. To render such an opinion, the valuation professional must perform extensive due diligence, and since investors do their own due diligence as part of the decision-making process, there is no need for the venture to pay for it.

Instead, entrepreneurs must demonstrate that critical economic drivers have been identified and considered – that they’ve done their homework. Negotiations should start with, “Based on our research and analysis, our comprehensive model indicates that the company is worth $XX,” rather than, “The valuation professional we hired says you need to pay $XX.” Demonstrating knowledge and preparedness goes a long way toward ensuring that you raise capital, and raise it at a valuation that reflects the venture’s true potential. By developing robust, user-friendly negotiation tools – financial models and valuation analyses – that clearly and credibly communicate thorough analysis and reasoning, Cayenne helps ensure a fruitful capital raising process.

Our Approach

Cayenne Consulting custom develops financial models, business valuations, and startup valuations that capture the unique dynamics of each venture. Key objectives include:

• Creating user-friendly, logical interfaces for management and investors to modify inputs (assumptions) and test multiple scenarios quickly and easily
• Communicating financial potential to investors and other stakeholders clearly and credibly
• Equipping management with a robust, user-friendly budgeting and strategic planning tool
• Providing insights to help further improve the business model
• Preparing entrepreneurs to enter investor discussions from a position of credibility and strength

Business valuation, including the startup valuation subcategory, is a specialized field that relies on an array of business, economic, and financial concepts. Analysts who perform business valuation consulting services and startup valuation consulting services engage in a rigorous process, incorporating methodologies and theories consistent with generally accepted business valuation principles.

To determine an appropriate fair market value (FMV) for a closely held company, the business appraiser starts with a strong understanding of public market dynamics – rates of return, earnings multiples, revenue multiples, EBITDA multiples, and other metrics observed for comparable publicly traded companies serve as a starting point for private company business appraisal. The business appraiser takes those metrics and makes adjustments – generally negative adjustments – to take into account the additional risk, lack of liquidity, and absence of historical information characteristic of privately held, and in particular early stage, companies.

Drawing on real-world and academic valuation experience, we take a bottom-up approach that incorporates the economic dynamics specific to the subject company and its industry sector. Functionality and user-friendliness are paramount. The user – whether the entrepreneur, investor, or other stakeholders – can adjust assumptions quickly and easily. Clearly understandable exhibits present the most pertinent takeaways. Formulas performing the gory calculations are kept behind the scenes.

Related Articles & Notes

• High Tech Startup Valuation Estimator by Akira Hirai – Answer 25 multiple-choice questions to get a rough idea of what your tech startup might be worth (for educational and entertainment purposes only).
• How Can My Partner and I Value Our Company? by Jimmy Lewin
• Rise of the $3.4 Billion Taxi Service, and Other Valuation Tales by Shyam Jha
• Startup Valuation Methods & Heuristics by Marty Zwilling
• Do You Have a Venture Value Scorecard? by Akira Hirai
• What’s Your Company Worth? by Jimmy Lewin
• How Much is That Invention Worth? by Shyam Jha
• How Much Capital Should Your Startup Raise? by Marty Zwilling