Methods for evaluating a startup. Continuation

The article is a continuation of the first article of a series of analytical articles on the evaluation of the financial component of a startup, its target audience, designed to help the authors of the projects.



From the idea of ​​a startup to get the first investment you need to go through several steps. One of them is an adequate assessment of a startup. Clear methods, giving a reliable figure - no! But the assessment is needed, both the investor and the author himself.



How to get it? ...

Methods for evaluating startups.

RVC specialists believe that the project’s potential should be analyzed first by a business expert, and not a technologist, and he assumes that the proposed technology works and the product has already been created. At this stage, he assesses the possibility of building a profitable business. Alas, but very often projects never reach the technologists. Let's look at the most popular assessment methods.

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The cost method (recovery).

The method allows to assess the real financial costs of creating a similar project, based on:

- the current market value of the specialists working on the project,

- costs of legal and official formalities, licensing, patenting, etc.

- existing assets, fixed assets, etc.

- expenses on the purchase of a share from investors of the previous stage of financing.

- the cost of third-party services related to the project (customized marketing research, preparation of TK, etc.)

- The current costs of advertising, promotion, recruitment of the project audience.



Example: (Calculate yourself the cost of reproducing the project Twitter or Facebook and compare with its current value)



This method is good because it allows you to evaluate the effectiveness of spending money by a startup team , and is convenient for an investor when bargaining with a start-up with his low estimate.

The negative side of this method lies in the fact that it does not take into account the cost of intellectual property, the evaluation of the personal initiative of a start-up, and other intangible values.

It serves as a basis for evaluating startups using several different methods.

Burkus method.

First published in 2001 in the book “Winning Angels” by Harvard's Amis and Stevenson. The main idea embedded in the method of Burkus: taking into account the potential of a startup with the help of some empirical coefficients to the recovery method.

Odds that I came across in open sources:

• Premium for an attractive idea - 20% - 40%
• Premium for competent and professional project management - 20% - 80%
• Professional board of directors, highly qualified project mentor - 10% - 40%
• Extra charge for the uniqueness of the market position (participation of state structures, a major strategic partner, a high threshold for entering competitors' market, etc.) - 10% - 20%
• Implemented prototype - 20% - 40%
• CashFlow - 20% - 40%

Or, as a special case of the method, in absolute terms for projects with a replacement cost of 800 thousand to 2 million dollars.

Add $ 1 - 2 million if there is:

• Great idea
• Prototype (reduction of technological risks)
• High-quality management team (reduced execution risk)
• Strategic relationship (reduction of market risk)
• Product introduction or start of sales (reduction of production risks)

The author himself has repeatedly revised the coefficients, entered them in percentage form, then changed them to absolute values ​​and returned again to percentage ones. Like any empirical assessment, the method suffers from personal bias and attempts to adjust to the current market moment.

The method of profit margins (venture capital method) through the forward value.

Calculation of the future value (forward value) of the planned investment using the formula:

FV = PV (1 + r) N,

where FV is the forward value, the future value of the investment (after 5 years)

PV - present value, the value of investment at the moment

r - target rate of return (IRR),

N is the period during which the investor’s money works in the project (the number of years before the investor leaves the startup).



Example: with a 50% annual IRR and a 3-year investment period, the future value of a $ 100,000 investment is FV = $ 100,000 x (1 + 0.50) * 3 = $ 450000.

Profit rate method (venture capital method) via terminal value

Calculation of the final value (terminal value) of the company at the exit of the investor. The simplest, but not the surest way: to peep the state of a competitor’s company, or a peer company. Then, by a key indicator, or a combination of them (number of customers, sales, market share, etc.) to determine.



Example (continued): if the predicted net income of a startup after 3 years is $ 100,000., And the average ratio of price to net income for comparable analogue companies is 15, then the company's predicted value in 5 years is equal to TV = $ 1 million x 15 = $ 15 million



Determination of the required share in the company's share capital (i.e. ownership share) In order to determine the share in the equity capital required by the investor, the future value of the investment (first stage) should be divided by the predicted final value of the company upon exit from the investment.



Example (continued): share in capital (ownership share) = $ 4.5 million / $ 15 million = 30%.



Profit rate method (venture capital method): calculation of the pre-investment and post-investment cost of a startup.



Example (continued): If 30% of a company is acquired by an investor for $ 1 million, then the full post-investment value of a company is $ 1.00 / 0.30 = $ 3.33 million. The company's pre-investment value = $ 3.33 - $ 1 million (investment) = $ 2 , 33 million



Both ways of calculating with the “Rate of Return method” are estimated not so much by the cost of the startup itself as by the effectiveness of the investment in the project . But to talk with an investor - isn't this the key point?

The method of assessing the potential audience at the cost of the client.

This method can be used to assess the future value of a startup, the success of which is closely related to the gained customer audience.

At the same time, it is important that the “price” of an individual client does not have a wide variation among companies operating in this sector of business. Such an assessment method is similar to the analogy method, but it has more objective results, since with the right approach, you can average overvalued and undervalued projects.



Example: For a startup that focuses on the provision of mobile services, the calculation on the client base is the most adequate estimate. The cost of one client for different companies - mobile operators does not have a wide variation. This option is available in open sources. By estimating the expected number of project clients in a future period and multiplying them by the current cost of the MTS or Beeline client, you can get the estimated cost of the startup at the time you reach the planned indicators.

When calculating the current value of the future cost of a startup, it is necessary to take into account risks (from 90% at the Pre-seed stage, up to 30% at the growth stage), cost of money, discounting, etc.

The method of assessing the potential audience for customer profitability.

This method is perhaps the most accurate economic method for calculating the future cost of a project. It is based on the standard method of business valuation by income (Income Method, BSV VII).

Based:

• the current profitability of a single client averaged over the business area of ​​a startup;
• expert evaluation, or prognostic calculation of the number of clients at a certain stage of development of the project, you can calculate its future value.

Example: The average income from one client of a game application to a social network is $ 10 / year. The cost of attracting one subscriber to the game application is $ 5. With an advertising budget of $ 50,000, you can expect 10,000 subscribers. Accordingly, the annual income of such an application is $ 100,000 / year. The cost of such a project after 1 year is $ 300,000 (3-fold annual income)

Exactly the same calculation can be made through the indicator of profit for 1 client.

The method of estimating the prospective cost, based on the coefficients (multipliers) of P / S, P / E, P / B and others.

The most popular option is the P / S “capitalization to revenue” ratio of two to four times the amount depending on the industry.

In this case, it is necessary to compare, as a rule, with the multipliers of companies trading on the exchange.

The application of the method is justified in the later stages of financing.

The method of calculation for the model Ave Maria.

Ave Maria model (free abbreviation for Acquisition, Value, Engagement, Monetization, Retention, Intellectual Property).

The author of the model is Maxim Kraynov (Kraynov Investments).

• Acquisition (Receipt of new customers or users). What is the audience of the project, what is its size, how can it be described and characterized? Through what channels, partners can you attract the described audience, how many people can you eventually attract as users (clients)?
  
  
• Value (value - the author recognizes that the term is unsuccessful, it would be more correct to Cost - costs). How much is a visitor, how much is a user (client)? What is the cost of attracting a user (client) in different channels? What influences the cost of attraction? What is the marginal cost of attraction?
• Engagement (user (client) involvement). Description of preferred actions for active and passive users, as well as secondary, side effects. This also includes the interaction of users (clients) with each other.
• Monetization (Monetization project). How will the number and activity of users be converted into project revenue? Additionally, you can describe different ways of monetization for different segments of users. At what point does the user pay for himself?
• Retention (customer retention). A description of how to get the client back, turn him into a regular user, convince him to pay for membership (status)? All this relates to the topic of customer retention. How will the budget be distributed between attracting new customers and keeping old ones? Comparison of LCV (Lifetime Customer Value - the amount of money brought by the client to your business), the cost of attracting a client and the cost of retention.
• Intellectual Property (intellectual property). How does the company protect itself from the machinations of competitors and from the fact that a disgruntled employee leaves and opens a competing company? How can a company protect itself from copying the implementation of a working idea?

This method does not provide estimated project characteristics, but is convenient for comparing different projects when choosing the preferred direction of investment.

Scoring Method.

The author - investment "angel" Bill Payne. The method is also known as the Bill Payne method or benchmarking method (Bill Payne Method, Benchmark Method).



This method compares the company with other typical angel-funded startups and adjusts the average estimate of newly funded startups in the region to get an estimate of the startup before the first earnings. Such comparisons can only be made for companies at the same stage of development, i.e. before the start of income. The methodology is similar to the Brooks method, but is tied to specific local conditions.

1. The first step in using the method is to determine the average rating of the company in this region and in this sector of the economy. The average rating may vary from region to region depending on the state of the economy and the competitive environment for startups. In most regions, this estimate does not change significantly depending on the sector of the economy. (Unfortunately, in Russia such data is not widely available, but nevertheless, they are already collected and analyzed)
2. The second step in determining the start-up valuation prior to the receipt of revenue is, using the scoring method, to compare the acquired company with your data on such transactions with consideration of the following factors and factors affecting the valuation cost:

• Having a strong management team: 0-30%
• Market size: 0-25%
• Product novelty and technology: 0-15%
• Competitive Environment: 0-10%
• Marketing, sales channels, partnership: 0-10%
• The need for additional investment: 0-5%
• Other factors: 0-5%

Subjective ranking of factors is typical for investor evaluation of startups. Some may be surprised that the value of the product and technology is lower than that of the management team and the size of the market. In building a business, team quality is the key to success. A good team will be able to detect product flaws at an early stage and correct them, and opportunities to increase sales and business scalability are important for future investor income. Good product and intellectual property are important, but the quality of the team is key.



Example: To illustrate the calculation, we take a company with an average product and technology (100% of the norm), a strong team (125% of the norm) and a large market size (150% of the norm). The company will be able to achieve a positive cash flow with a single angel round of investment (100% of the norm). Considering the strength of competition in the market, the company is weaker (75% of the norm), but initial consumer reviews of the product are very good (Other factors = 100%). The company needs some additional work when establishing sales channels and partnerships (80% of the norm). Using this data, we can make the following assessment:

Factors for comparison	Range	Startup	Factor
Having a strong management team	30% max	125%	0.3750
Market size	25% max	150%	0.3750
Product and technology	15% max	100%	0.1500
Competitive environment	10% max	75%	0.0750
Marketing, sales channels, partnership	10% max	80%	0.0800
The need for additional investment	5% max	100%	0.0500
Other factors (good customer reviews)	5% max	100%	0.0500
TOTAL			1.0750

Multiplying the sum of the factors (1.075) by an average estimate of $ 1.5 million, we will get an estimate of the acquired company at $ 1.61 million.



The key point in the scoring method is an understanding of the average rating of companies until the income in your region . With this data, the scoring method gives investors subjective methods to adjust the valuation of the acquired company for the seed and initial investment rounds.

PVN method.

The most common method for evaluating startups is the PVN method. This is a kind of expert assessment, widely used by the Guru IT Department in the region, in particular, according to unconfirmed data, by Steve Jobs himself (it is enough to read the biography of Steve Jobs).

The abbreviation of this method comes from the first letters of the popular phrase “Palchem ​​v Nebo” .

Despite its “anti-science”, the estimates obtained on the basis of this method, with good investor intuition, are the most reliable and reliable.



The choice of evaluation method used, depending on the stage and direction of the startup

Depending on the stage of development of a startup for its evaluation, it is desirable to select a method that more adequately takes into account the current stage. Of course, no method will give a reliable assessment of a startup, especially in the early stages.



We would recommend at the early stages to use predominantly estimated or expert methods, at the later - calculated ones.

To be continued

If a respected community shows interest in this topic, we will tell in the following articles:

• How to enter the market
• On the definition and assessment of the target audience of a startup
• Let us show by the examples of real startups the calculation of financial attractiveness

Author: Dmitry Chernyak (business angel, info@findstartup.ru).

Collaborators:

• Roman Bobkov (investor, rbobkov@gmail.com),
• Zhuravlev Ivan (business angel, info@findstartup.ru),
• Oleg Ratunin (creator of the project napartner.ru, okolovas1@gmail.com).

PS For an article with examples of calculation, you want to evaluate your startup.

Warn immediately - there will be no freebies. You will conduct an assessment of your own project yourself, but under our strict guidance. We will study your project, prepare a questionnaire and help you calculate the cost of the project. Those interested can unsubscribe in the comments, or info@findstartup.ru.

The most interesting and developed estimates will be published on Habré as illustrations to the methods of calculation.



PP S Continuation of the series “Startup time to market”