In order to evaluate a company, an initial understanding of the valuation methods is essential. Therefore, at Venture Valuation, we pursue a holistic evaluation approach. All valuations are based on a careful consideration of both hard facts and soft factors. We apply a thorough risk assessment of factors which include:
To determine the value of a company as accurately and as objectively as possible, we use a mixture of different assessment methods. All methods are specifically suited for the evaluation of technology companies, with high growth potential and start-up companies of all types. Although not every valuation method is appropriate, Venture Valuation assesses each company according to its industry and financing phase.
Method: The discounted cash flow method takes free cash flows generated in the future by a specific project / company and discounts them to derive a present value (i.e. today’s value).
The discounting value usually used is the weighted average cost of capital (WACC) and is symbolized as the ‘r’ in the following formula:
DCF = Calculated DCF value
CF = Cash Flow
r = Discount rate (WACC: Weighted average cost of capital)
Uses: DCF calculations are used to estimate the value of potential investments. When DCF calculations produce values that are higher than the initial investment, this usually indicates that the investment may be worthwhile and should be considered.
Method: The risk adjusted net present value (rNPV) method employs the same principle as the DCF method, except that each future cash flow is risk adjusted to the probability of it actually occurring.
The probability of the cash flow occurring is also known as the ‘success rate’.
Uses: Risk-adjusted NPV is a common method of valuing compounds or products in the pharmaceutical and biotech industry, for example. The success rates of a particular compound/drug can be estimated by comparing the probability that the compound/drug will pass the various development phases (i.e. phases I, II or III) often undertaken in the drug development process.
Also known as: NPV, eNPV (e=estimated/expected)
Method: The Decision Tree Analysis is based on the same
approach as the Risk-adjusted NPV. Decision trees are used to forecast future outcomes by assigning a certain probability to a particular decision.
The name Decision Tree Analysis comes from the ‘tree-like’ shape the analysis creates, where each ‘branch’ is a particular decision that can be made.
Uses: Decision trees are used to provide a graphical representation of options, strategies or decisions that can be undertaken to achieve a particular goal or ‘decision’.
Method: The venture capital method reflects the investor’s process of looking for an exit within 3 to 7 years. First an expected exit price for the investment is estimated. From there, one calculates back to the post-money valuation today, considering the time and the risk the investors take.
The return on investment can be estimated by determining what return an investor could expect from that investment with the specific level of risk attached.
Uses: The venture capital method is an often used in valuations of pre revenue companies where it is easier to estimate a potential exit value once certain milestones have been reached.
Method: The market comparables method attempts to estimate a valuation based on the market capitalization of comparable listed companies.
Uses: The market comparables method is a simple calculation using different key ratios like earning, sales, R&D investments, to estimate the value of a company.
Also known as: Multiples
Method: The comparable transaction method attempts to value an entire company by comparing a similar sized private company in a similar field, and using different key ratios. The price for a similar company can either come from an M&A transaction or a financing round.
Uses: The comparable transaction method is a simple calculation estimating the value of a target company based on comparable investments or M&A deals.
Method: The sum of parts valuation is an aggregation of different parts of a company. You might value lead assets separately with rNPV calculations and the platform, pipeline or service part with a discounted cash flow valuation. Also general expenses have to be included as a separate part or in the pipeline/service part. Adding up all parts results in the sum of parts valuation.
Uses: The sum of parts valuation is typically used to calculate the value of a company, which has different assets / business models with different risk and thus discount rates. A typical example are therapeutic biotech companies.
Also known as: Sum Of The Parts (SOTP)
For more information on valuation methods, see our reports and analyses or interview series. Or read the book by our CEO Dr. Patrik Frei: Frei, P., Assessment and Valuation of High Growth Companies, Bern: Haupt Verlag, 2006 (also available on Amazon.de).
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