Venture capital firms in Canada and the United States take different approaches to valuation, “your $1m valuation does not mean $1m in venture capital funds perspective.>.
Adventure head mode
The estimated capital method is one of a family of valuation processes that rely on working back from an assumed term value, that is, the sale of the investment at some future time. With the venture capital method, you take the terminal value of the company and add it to the sum of interim distributions (if any) to find what the investor is worth, expressed in today’s dollars. To better understand art, we first need to review the process.
If an investor plans to invest 10 dollars (say, $50,000) in your venture today with some as-yet-to-be-determined percentage of the company’s equity, the first task is to see if the company can be valued based on existing numbers. and other arguments to compare it with similar companies. Perhaps it looks like another firm for which investors, or the public market, have established a value. There is an easy way: a strong comparison.
Well, now I assume that society lacks enough shape and texture to perform a comparable analysis in today’s facts. In this case, you need to look at the future company through your crystal ball.
Make project managers predict that the company will enjoy a net profit of 10 cents after the assessment as the day the exit plan is made” the day the company is sold or goes public ‘” and that happy day is five years from To determine how much money a company’s stock can sell for in a merger or IPO five years down the road, the financial analyst then picks an exact multiple of earnings per share.
Unfortunately, because you have no way of knowing for sure what that particular multiple will be five years from now, the next best strategy is to use multiples given the industry. So you’ll want to ask what the ratio (or PE) of earnings on the stock market is today.
Assuming that the average of those multiples is 10 (a nice round number to work with), that is, when applied to your company, its total projected of all the company’s stock immediately before the IPO” will be 10 times the net profit for the year in which the projections were made.
The investor then chooses to return on the investment, which corresponds to the risks that he thinks the business is taking. taking into account the return on the investment, again a subjective judgment. He believes that he owes 38 percent of the compounded income (the borrowed percentage of the interest earned, which is then compounded or added to the original amount for subsequent calculations). This means that the company’s forecast is expected to support five times earnings; that is, the investor returns $5 for every $1 invested, before taxes.
So the valuation formula is relatively simple: If the investment is $250,000, five times $250,000 is $1.25 million. If the company is expected to be worth $10 million in year five (that is, 10 times the projected net profit in year five of $1 million), then the $250,000 investor commands 12.5 percent of the company in year one.
If the time horizon is five years, then;
- To triple the five-year investment, you need 25 percent of the pre-tax compounded income.
- You need to quintuple your money invested in five years, with a 38 percent pre-tax compounded return.
- For a return of seven times the five-year investment, you need 48 percent.
- For 10 times the investment one needs a 58 percent compounded pretax return.
Venture capitalists use any number of rules when determining whether the potential payoff from an investment will be worth it to them.
By using the venture capital method accurately, you must determine the likely range of subsequent investments, which (unless the investor participates) dilutes his ultimate interest. The investor must participate in the subsequent rounds of financing as a percentage of his initial maintenance.
