When looking for comparable companies, they do not have to be in the exact same sector. What’s important is that they possess a similar business model to the company you are building. For example, if you are building a software-as-a-service business, then it would be useful to look at companies such as Open Table, Sales Force, DropBox, Box and others.
www.box.com
Step one Identify the Total Addressable Market The Total Addressable Market (TAM) provides an indicator of the potential size of the business in the future, and is something that we look at in detail when we invest in startups. We always look for bottom-up sizing, rather than top-down because it provides a much more realistic and measurable indicator of size. An example of a topdown analysis is: the size of food and beverage spend in MENA is US$10bn and if I can capture 2% of that market, my business can reach $200m in sales. As you can see, it’s very subjective and macro in nature, without going into the actual market that one can sell to. An example of a bottom-up analysis is: if I am selling real estate listings to brokers and there are a total of 10,000 real estate brokers in my market, of which 1,000 real estate brokers are sellable, where I can charge them $1000/month, then my addressable market is $12m. It’s clearer and more measurable in description, and it provides a realistic estimate of what your business can generate “if all goes to plan.” Once you’ve identified the TAM and with that, the potential size of the business, you are on your way to building the foundation of your valuation. Step two Find comparable companies When looking for comparable companies, they do not have to be in the exact same sector. What’s important is that they possess a similar business model to the company you are building. For example, if you are building a software-as-a-service business, then it would be useful to look at companies such as OpenTable, Sales Force, Dropbox, Box and others. You need to look for data related to sales, earnings before interest, taxes, depreciation, and amortization (EBITDA), and valuations -or market capitalization/enterprise value if you are looking at public
companies- of public or private companies. Typically, early stage companies are lossmaking, and so sales can be used as a proxy even though it’s not a real driver of value (compared to EBITDA, given that EBITDA is a closer proxy to cash flows and inherent value). The next step would be to take an average of the Price/ Sales or EV/Sales, and EV/EBITDA ratios for those companies, and attach a discount rate to account for the liquidity risk, market risk and other factors related to the market you’re in. For MENA, at least a 30% discount rate is appropriate. You will then arrive at your multiple, which will be important when assessing the valuation. Step three Develop valuation scenarios The idea here is to determine projections of your business over a five to seven year period. We like longer horizons at BECO, given that we are a holding company, not a fund, and therefore do not have a finite life. Your projections should have already been built ahead of this exercise. The important thing is to understand how big the business can be, both in terms of sales and EBITDA (since as the company matures, it should become profitable and reach somewhat stable margins). Develop at least three different scenarios for these projections- we call them “Poor,” “Good,” “Great,” and sometimes we include a “Home run” scenario. These different scenarios allow you to account for execution risk and potential issues with market-uptake or
other things that can impact the growth of the business, and therefore the overall outcome. Once the projections are complete, the next step is to use the sales and/or EBITDA figures and attach the multiple created in the previous step to come up with valuation scenarios. For example, in the “Good” scenario, your company will generate $20m in year six, and companies similar to yours trade at 5x sales. If you apply a discount rate of 30%, you will have an average ratio of 3.5x sales, and therefore a valuation of $70m. >>> may 2015 Entrepreneur
83