All people working in the Startup / Early Stage consistently asked the same question,
“How do you value business?”
The correct answer is there is no correct answer
Without trying to be facetious here is a number of models that may help.
Anyone wanting further information can attend Richard’s BEERonomics in a pub near you.
Courses in advance corporate finances cost you 2 beers / hour (Cheaper than a MBA)
- Sales Revenue
Most businesses are valued based upon revenue.
This means a business with $1 Million revenue would be valued @ $750,000 to $1,250,000
or values each dollar sales between $0.75 – $1.25
- Price Earnings Ratio
This is the number of years of after tax profit it takes to return your investment
A typical private company sells for a PE of 2-5 where public companies sell for 8-20.
Google sells with a PE 48Many people use EBIT, Earnings (profits) Before Interest and Tax as a measure of how much extra debt a company can take to help pay for the take over.
- Discounted cash flow (DCF)
This technique combines all the cash generated from the business and then discount
(reduces) them to a present value. (ie A dollar today is worth more than a dollar tomorrow)
This can be a problem if the wrong interest (discount) it used.
BTW, The interest rate is ALWAYS WRONG
- Replacement Value
How much would it cost to get similar stuff either new or used?In software, many people use COCOMO which is a formula that count lines of code and examines the complexity of code thereby allocating a amount of developers time it would take to replicate it.slccount Is a free COCOMO tool that supports about 27 different languages.
For many software startups this is a good starting point.
- Return on Investment (ROI)
This combines a number of the above techiques to derive a single figure.Many early stage investors Angels / VCs demand +45% ROI as compensation for the higher risk associated with early stage. This is a serious market failure.
A team of 3 developers have written 13K lines of PHP source code to develop a DIY superannuation management software. It has taken 6 months part time (ie 50 hour/wk)
They are all leaving their “real” jobs to pursue their dream.
Total Cash Spent: $5,800
What is the company worth?
1. Sale Revenue Nil
Future Sales Revenue 2009 $1,000,000 (FV)
Discounted @ 40% pa $510,000
Company valuation $383,000 – $637,000
2. Price Earnings
2009 Sales $1,000,000
2009 Profit $180,000
PE 2 (180K x 2 x 40%) $183,000
PE 5 (180K x 5 x 40%) $459,000
Company valuation $183,000 – $459,000
Replacement value $413,228
The following output is from a real project
Totals grouped by language (dominant language first):
php: 13409 (99.83%)
sh: 23 (0.17%)
Total Physical Source Lines of Code (SLOC) = 13,432
Development Effort Estimate, Person-Years (Person-Months) = 3.06 (36.71)
(Basic COCOMO model, Person-Months = 2.4 * (KSLOC**1.05))
Schedule Estimate, Years (Months) = 0.82 (9.83)
(Basic COCOMO model, Months = 2.5 * (person-months**0.38))
Estimated Average Number of Developers (Effort/Schedule) = 3.73
Total Estimated Cost to Develop = $ 413,228
(average salary = $56,286/year, overhead = 2.40).
As you can see there is no right answer but valuation is much more about art than science.
Â© 2007 Richard Hayes RHI Ltd reprinted by permission.