INTANGIBLE CAPITAL VALUE
by Erwan COATNOAN DE KERDU
Your copilot in creating a successful company
Startups: how do we value them?
It is not easy to evaluate a business that has not yet had time to prove itself. There are no results or balance sheets to give you an idea of its potential and value. But there are other ways to value a start-up.
The real options
The real options method is perfectly adapted to startups. It is inspired by the financial valuation, which is based on the constitution of a tree structure, complex or not, depending on the projects under consideration. A decision (and a direction) is taken at each node of the tree and there are two variants. One can implement a continuous mode, with a starting point and an ending point, without intermediary. Or we can implement this method step by step, in discrete mode. This method also has some limitations. Real options are valued in the same way as financial options. However, certain conditions are difficult to meet in start-ups: a complex approach, difficult scenarios to be imagined by the founders, illiquid underlying…
This method is also called the discounted cash flow method and is the most common. It is therefore based on certain characteristics. Its principle is to measure the value of an asset that will generate future net income. It will then depend on the size of the cash flows, their predictability and the time over which they will be generated. This method includes an explicit horizon and an implicit horizon. The terminal value covers the latter and is generally calculated on the basis of an increasing annuity or an exit multiple which is based on an aggregate profitability, which may be the operating result or the gross operating surplus.
There are some limitations to this method. To determine future flows, a business plan is required. But it is not easy to be sure of the plan provided, its relevance and its level of detail. The entire method is based on the business plan and the type of approach used. Moreover, the strategic vision and objective must be in line with the means deployed: working capital requirements, investments…
The multiples method
This method has this name because it is based on a comparative approach of the startup with listed companies. It consists in comparing the company with its listed peers. A form of calibration is performed on the units of the revenue measures, and it is applied to the value of the startup. However, there are some limitations to this method. And it requires a lot of caution. The comparables and the startup being compared must be exposed to the same risks, have the same revenue growth rate, have similar investment needs and structure, be profitable, etc. This method should be used with caution, as the conditions are very difficult to meet. And it is not possible to compare companies that have nothing in common.
The First Chicago Method
This is a variant of the discounted cash flow method, which is quite similar to DCF. However, the principle is to determine the outcome of several scenarios (three) and to discount them at a rate considered realistic. These three scenarios are then assigned a probability of occurrence. And the value of the company is determined by making a weighted sum of these three scenarios. This method is flexible and incorporates what is known as a notion of optionality, since there are three possible scenarios. Nevertheless, it has its own limitations. The approach relies heavily on human judgment. A person must then determine the relative weights to be given to the probability of occurrence of each of the scenarios, and explain why.