Chapter 9. Valuation of Companies

INTRODUCTION

The company recruits employees, calculates the feasibility of projects, and raises capital and debt in consideration of the company's value and the value of its growth opportunities, and hence valuating a company has a crucial impact on the venture development.

Market price can provide a basis for valuing public companies. The valuation of private companies, however particularly startups is more complicated. The main reason for this is that startups are plagued by more uncertainties: By definition, startups are in an earlier phase of their life cycle than are public companies, and therefore the uncertainties clouding the technological feasibility and managerial abilities of the companies and the existence of a market for their products are higher.

This chapter briefly presents the main methods for valuing companies. These methods are commonly used among investors either private investors, venture capital funds, or companies but they are certainly not the only methods for valuating companies. The appropriate model should be chosen carefully, since specific adjustments are always required in accordance with the characteristics of the valued company. In any case, a company should be valued using several methods to enable comparisons among the results of each method.

Obviously, a valuation performed without an in-depth analysis of the company's technology, managerial abilities, access to markets, and competitive situation is meaningless. Since these issues are addressed in other chapters, the methods presented in this chapter are based on the assumption that such an in-depth analysis has already been performed. The models are presented based on the assumption that the investor is a financial investor, i.e., an investor who values the company according to the direct financial cash flows he expects to derive over time from his/her holding of the company's shares. This presentation is followed by a description of the adjustments made by strategic investors to the models.

Ostensibly, one would expect all financial investors to reach the same valuation upon concluding their calculations. In practice, different investors will usually reach different valuations because, among other things, they use different models and rely on different assumptions. While in theory most of the models are supposed to yield the same result, but different assumptions used by the investors with respect to parameters required by the models will typically cause a difference in the implementation of the different models, even when these valuations are conducted by the same people.

Although valuations produce numerical results, no exact number can represent the "true" value of a company at any given time. Value is almost always subjective, since different investors attribute a different value to the same asset (in this case, the company). For instance, from the standpoint of some investors (namely, strategic investors), an investment in the company carries additional value, such as direct contact with innovative technology. Likewise, a company would sometimes be prepared to admit such investors based on a low value, since they bring an added value to the company such as ties with potential customers. This is another example illustrating a main point in valuation of emerging companies, and in particular in the context of capital raising: From the entrepreneurs' perspective, the ultimate objective is to maximize the value of their share in the company in the long run and not to maximize the value of the company at any given point of time.