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Valuation

Valuing early-stage companies can be more of an art than a science. Here I'll explain the basics behind discounted cash flow (DCF) and multiple-based valuation, and detail how they are implemented in Hemrock's models.

Valuation is tricky. The math isn't hard; applying it correctly takes experience and context. Building a DCF in a spreadsheet is easy - making sense of it in a real situation is harder.

How it works in Hemrock models

The Forecast sheet in the Standard Model calculates a discounted cash flow and an EBITDA multiple valuation from the projections. Tread carefully. Valuations are highly dependent on industry-specific assumptions and the variability of underlying cash flows. Don't forget the art behind the math.

When sharing the model with investors, many founders remove the valuation calculations from Forecast to keep the discussion on the business, not the exit.

From the assumptions on Get Started, the valuation calcs on Forecast calculate the valuation at each point in time - the valuation at the end of every month, quarter, or year - based on history and expectations.

Inputs

Valuation assumptions are on Get Started.

DCF Method

  • WACC (used as NPV Discount Rate). Industry-specific WACC data.
  • WACC (quarterly) - converted to a quarterly rate for NPV.
  • WACC (monthly) - converted to a monthly rate for NPV.

Terminal Value Calculation (for DCF)

  • Discount Rate (WACC)
  • Long-Term Growth Rate. Pick a long-term rate applicable for your company or industry. Dataset here.

Multiple Valuation Methods

  • Valuation Multiple: X multiple of Revenue - Multiple of trailing 12 months net revenues. Industry-based comparable multiples require research and analysis for your industry.
  • Valuation Multiple: X multiple of EBITDA - Multiple of trailing 12 months EBITDA. Industry-based comparable multiples require research and analysis.

Common Modifications

These calculations are not commonly modified, but can be changed or extended based on the specific situation.

Using Equidam for Valuations

Equidam provides third-party valuations. Sign up, fill out the questionnaire, input your financial projections (which can be generated from any Hemrock model), and Equidam creates a valuation through a weighted-average of five methodologies. 1

A few methods commonly used to value companies.

Discounted Cash Flow

DCF values a business based on its future cash flows.

  1. Forecast the company's future free cash flows (net income, adjusted for non-cash expenses, CAPEX, and working capital).
  2. Discount the cash flows to present value, typically using weighted average cost of capital (WACC) as the discount rate.
  3. Sum the present values to get equity value, then adjust for cash and debt to get enterprise value.

DCF works well for mature businesses with stable, predictable cash flows. For startups with variable cash flows and no revenue history, DCF is challenging.

DCF primer. DCF explanation.

Multiple-based valuation methods

Comparing a business to sales of comparable businesses, usually calculated as a multiple of revenue or earnings (often EBITDA). A company sold for $50mm with TTM revenues of $10mm was valued at 5x trailing 12 revenues.

Multiple-based methods rely on finding comparable companies and transactions. Easier for public companies (more data); harder for private companies. Still requires interpretation - comparing margins, growth rates, business model sustainability, and growth potential takes judgment.

Multiples-based valuation primer. Overview of valuation methods. Valuing an online business.

Valuation firms often use multiple methods - including qualitative scorecards and industry-specific techniques - and weight them for a range-based, weighted-average valuation.

VC Method

The VC Method is helpful for early-stage companies. Estimate the future exit potential, time to exit, and funding required. Calculate the valuation today needed for the investor to achieve a target rate of return given the investment amount. Straightforward but requires a lot of assumptions.

To justify a fundraising round valuation, remember: round size divided by target ownership percentage sold equals postmoney valuation. Compare to similar funding rounds.

Another method: forecast future funding rounds, create an exit waterfall for a range of exit values, and probability-weight the outcomes for a risk-weighted average return. See Hemrock's Venture Valuation Tool.

The Aswath Damodaran interview covers the levers of valuation beyond the numbers.

Footnotes

  1. Links to Equidam are referral links for which Hemrock receives a percentage referral fee. ↩