42 · MONE Y
S TA R T- U P S
START-UP COMPANIES ARE LIKE FINE ART: THEIR VALUATION CAN VARY SUBSTANTIALLY FROM PERSON TO PERSON The trouble with DCF is that the quality of the valuation obtained depends on the analyst's ability to forecast future market conditions and generate accurate assumptions about long-term growth rates. For many start-ups, projecting sales and earnings beyond even one or two years becomes especially challenging. Moreover, the value that DCF models generate is often highly sensitive to the expected rate of return and growth rates used for discounting cash flows. Therefore, DCF should ideally be used in conjunction with another method. One potential approach to applying a DCF valuation would be as follows: 1. Estimating the total market value for the start-up’s product or services and its expected growth. 2. Projecting market share acquisition over a timeline.
3. Forecasting cash flows by identifying the start-up’s potential free cash flow generation. 4. Determining: (a) an exit value if the founders envisage exiting their position after a number of years; or (b) a terminal value based on reasonable assumptions on cash flow growth to perpetuity. 5. Discounting all these cash flows at today’s cost of capital, bearing in mind the elevated risk borne by start-ups, and preferably considering comparative analysis with mature firms within the same sector. There are several other valuation methods for
start-ups which seem to be gaining traction by industry practitioners. However, these methods are often variations of the multiples and DCF techniques. Conclusion Start-up companies are like fine art: their valuation can vary substantially from person to person. This poses significant challenges for the independent valuer. However, the use of a combination of methodologies instead of a single one, as well as applying a valuation “range” as opposed to one fixed value, can help mitigate some of the risks inherent in valuation.