Equity Valuation Models

How does the #valuation of a company change with different #capitalstructures? When we do a standard #DCF for any company, especially a public firm, the most common approach is to estimate the enterprise value, then deduct the value of debt to determine the equity value and divide it by the share outstanding to arrive at the value/share. When the company is highly levered and at the same time is distressed, the market value of the debt is different from the book value. In that case, we determine the value of debt separately because any increase in default risk will increase the equity value (reflected by an increase in beta). What happens when you value a startup with different capital structures like: [1] Preferred stock [2] Stock options [3] Common equity [4] Debt The situation becomes complex when the startup raises financing at different periods. In such cases, it is not enough to arrive at the enterprise value but also to determine the value of different equity interests because of differences in expected cash flows (rights of preferred equity come with convertible options and liquidation preferences, while for debt, it is the right to cash flow and for equity, it is the right to residual cash flows) and differences in risk (Series A and seed financing investors carry a higher risk than Series D investors) and the values must get adjusted accordingly to account for this additional risk. I remember valuing a portfolio company of a VC when the firm raised a Series D round. I assigned the following scenarios in my analysis of prevailing market conditions: [1] A 30% probability of conversion of preferred to equity means the company will IPO. [2] 40% chance of sale to another VC where Series D investors receive 70% liquidation preference while Series A, B and C receive none. [3] 30% chance of liquidation where all investors receive ZERO return. Price/Share in Series D = 3 Shares outstanding = 50 Mn Post-money value = 150 Mn In this case, the Fair value of Series A, B and C shares = 3*(1-(40%*70%)) = 2.16 because if it is an IPO, the FV of all shares will be the common equity price and if it liquidation, the FV is zero. Last year, the portfolio company performed well, and the Post-money valuation increased to 200 Mn. Series D share price increased to 4 from 3, resulting in a 40% probability of an IPO and 30% of a sale. Here, the FV of Series A, B and C shares = 4*(1-(30%*70%)) = 3.16, a 21% discount against Series D compared to a 28% discount in the earlier scenario. What do I want to say? [1] The value of equity interests of a firm with a complex structure differs even if the enterprise value is the same. [2] Valuation changes with every measurement date and is a function of company performance and macro scenarios. Now you understand why early-stage investors carry the highest risk during a funding winter and force founders to have a down round because if they don't do it, they will get zero return.

Appraising a business isn't just about applying an EBITDA multiple and calling it a day. Each piece of the puzzle can materially affect the valuation. If you're doing FP&A advisory work, or serving as a Fractional CFO, clients will often benefit from a valuation model. The model doesn't need to be perfect, but it serves a couple of purposes: 𝟭) 𝗗𝘆𝗻𝗮𝗺𝗶𝗰 𝗩𝗮𝗹𝘂𝗮𝘁𝗶𝗼𝗻 𝗕𝗮𝘀𝗲𝗱 𝗼𝗻 𝗥𝗲𝗮𝗹 𝗙𝗶𝗻𝗮𝗻𝗰𝗶𝗮𝗹 𝗣𝗲𝗿𝗳𝗼𝗿𝗺𝗮𝗻𝗰𝗲 Instead of relying on a static, one-off valuation, an integrated 3-statement model allows you to automatically refresh the appraisal as actual financial results (income statement, balance sheet, and cash flow) evolve. The model will recalculate the company's value in real time as revenue, margins, working capital, or capex change. 𝟮) 𝗦𝗰𝗲𝗻𝗮𝗿𝗶𝗼 𝗣𝗹𝗮𝗻𝗻𝗶𝗻𝗴 𝗮𝗻𝗱 𝗪𝗵𝗮𝘁 𝗜𝗳𝘀 When the valuation is tied to full financial statement forecasts, you can easily run "what if" scenarios: How does a price increase or cost savings initiative affect the valuation? What happens if growth slows? By integrating assumptions into the model, you can help a business owner understand how these decisions impact value. 𝗪𝗵𝗮𝘁'𝘀 𝗵𝗮𝗽𝗽𝗲𝗻𝗶𝗻𝗴 𝗶𝗻 𝘁𝗵𝗶𝘀 𝗲𝘅𝗮𝗺𝗽𝗹𝗲? In this analysis, loosely based upon a real company (I’ve changed the figures and assumptions), I use both an NTM Revenue Multiple and an NTM EBITDA Multiple. NTM stands for next twelve months. That's why it's vital to have a 3-statement forecast model behind this analysis. For illustrative purposes, I weighted the two different approaches 50/50 to reduce reliance on a single method. However, it may be concerning that the gap between the indicated value of equity before adjustments ($31.5 million and $84.9 million) is so wide between the revenue and EBITDA multiples. This is why selecting the right market multiples and the right basis for the multiple matters so much. Rely on a questionable multiple or basis and you’ll end up be with a questionable valuation. The value may need to be adjusted for a control premium, recognizing that buyers often pay a premium to gain strategic decision-making power. The result: A marketable, controlling value of $83.2 million. 𝗪𝗵𝗲𝗻 𝘆𝗼𝘂'𝗿𝗲 𝗯𝘂𝗶𝗹𝗱𝗶𝗻𝗴 𝗱𝘆𝗻𝗮𝗺𝗶𝗰 𝗺𝗼𝗱𝗲𝗹𝘀 𝗮𝗻𝗱 𝘃𝗮𝗹𝘂𝗮𝘁𝗶𝗼𝗻𝘀 𝗳𝗼𝗿 𝗰𝗹𝗶𝗲𝗻𝘁𝘀, 𝗮𝗹𝘄𝗮𝘆𝘀 𝗿𝗲𝗺𝗲𝗺𝗯𝗲𝗿: (1) Different methodologies can lead to very different results. (2) Adjustments for control can move the needle dramatically. (3) A valuation isn't just a number. It’s a combination of judgement and assumptions. You can have two different Fractional CFOs who arrive at two different outcomes. That's why it's helpful to make integrated financial models flexible, so they can update and be adjusted with relative ease. These models help give business owners a reasonable basis for the worth of their companies. They deserve that.

Top Valuation Methods for Companies: A CPA's Perspective As a CPA, I've worked with various clients, from small startups to large corporations, and have seen firsthand the impact of choosing the right valuation method. In this post, we'll examine the three primary approaches: Income Approach, Market Approach, and Asset Approach. Income Approach The Income Approach focuses on a company's future cash flows, discounting them to present value. This approach is often used for businesses with stable cash flows and a clear growth trajectory. -Discounted Cash Flow (DCF) Method: Estimates future cash flows and discounts them using a weighted average cost of capital (WACC). -Capitalization of Earnings Method: Capitalizes a single year's earnings using a capitalization rate. Market Approach The Market Approach analyzes market data from similar companies and transactions. This approach is useful for businesses with comparable peers and market data. -Guideline Public Company Method: Compares the subject company to publicly traded companies. - Merger and Acquisition Method: Analyzes recent transactions in the industry. Asset Approach The Asset Approach values a company's assets and liabilities to estimate its net worth. This approach is often used for businesses with significant asset value or in industries with unique asset characteristics. - Cost Approach: Estimates the cost to replace or reproduce assets. - Sales Comparison Approach: Compares the subject company's assets to similar assets sold in the market. Choosing the Right Valuation Method Selecting the appropriate valuation method depends on the company's specific circumstances, industry, and purpose of the valuation. A combination of approaches may be used to ensure a comprehensive valuation. By selecting the right approach, companies can accurately determine their value, drive growth, and maximize shareholder wealth. In future posts, we'll explore industry-specific valuation challenges and best practices. Stay tuned!

Interested in investment banking careers? You'll need to master valuation. These are the techniques you'll need to know. Whether you’re interested in investment banking, private equity, or asset management, understanding valuation is critical. If you can’t confidently explain these methods, you won’t make it past interviews. Here’s your breakdown: 📊 Comparable Company Analysis (Trading Comps) – Valuing a company by comparing it to publicly traded peers. I. Key multiples – Enterprise Value/EBITDA, Price/Earnings, P/B (Price-to-Book), P/S (Price-to-Sales) (varies by industry). II. Industry-specific multiples: a. Tech → EV/Revenue (due to high growth). b. Banks → P/B (assets and book value matter most). c. Real Estate → Price/Net Asset Value, Cap Rates (focus on property values). 📈 Precedent Transactions (Deal Comps) – Using past Mergers & Acquisition deals to value a company. I. Transaction structure matters – Cash vs. stock vs. hybrid (affects synergies and risk). II. Premiums paid in M&A – Buyers usually pay 20-40% over market price to acquire control. 💰 Discounted Cash Flow (DCF) Analysis – Valuing a company based on future cash flows. I. FCFF (Free Cash Flow to Firm) vs. FCFE (Free Cash Flow to Equity) – FCFF values the entire firm; FCFE values just the equity portion. II. WACC (Weighted Average Cost of Capital) – Discount rate for FCFF, reflecting cost of debt & equity. III. Terminal Value (Gordon Growth Model (perpetual growth) and Exit Multiple Method (based on comps)). IV. Beta & Cost of Equity (CAPM Model) – Measures risk relative to the market. 🛠 Leveraged Buyout (LBO) Analysis – How private equity firms evaluate deals. I. How PE firms structure LBOs – Using high debt to amplify returns. II. Sources & Uses table – Shows where financing comes from and how it’s used. III. Key drivers of IRR (Internal Rate of Return) & MOIC (Multiple on Invested Capital) – Entry valuation, leverage, operational improvements, and exit multiple. IV. Debt structures in LBOs – Senior debt, mezzanine, PIK (payment-in-kind), high-yield bonds. 🏗 Sum-of-the-Parts (SOTP) Valuation I. Used when a company operates in multiple segments. II. Each business unit is valued separately, then summed to get total firm value. ⚖ Accretion/Dilution in M&A Deals – Does the deal increase or decrease EPS? I. Accretive deal – Increases EPS (often cash or low P/E stock deals). II. Dilutive deal – Decreases EPS (often high P/E stock deals). Valuation is both an art and a science. The best finance professionals don’t just plug numbers into models—they understand what drives value. Which valuation technique do you want to master? Follow me, Afzal Hussein, for daily tips on breaking into finance 10x faster. #Careers #Finance #Students

By popular demand, part 2 on ways to think about your equity at an early stage company. There are a few factors you need to understand to calculate the current and the potential value of your equity. You want to start with how many options you are being granted and what the strike price is for those shares. Strike price means what you pay per share to exercise those options. Then you need to understand the current or most recent valuation of the company. There are 3 parts to that equation: Number of shares outstanding x the value per share= valuation of the company. If a company has 10 million shares outstanding and the most recent valuation was $200 million, that means each share was valued at $20. If you have two parts of the equation, you can figure out the other one. If you knew the company had been valued at $200 million and that each share was worth $20, you'd know that 10 million shares are outstanding by simple division. In the above scenario, let's say you are offered 10,000 shares with a strike price of $2. Typically you would vest those shares over 4 years- 2500 shares per year. But you'd know that at the current valuation, you'd be receive $8 per share in value (the $10 valuation minus the $2 you'd pay to exercise). Multiply that by 10,000 shares and you'd calculate the total value as $80,000. If you think the company will be worth 5 times more in four years, you'd project the value of your equity to then be $480,000. The stock would be worth $500,000 and you'd have to pay $20,000 to exercise your shares. This is a simple way to help you calculate the current and future value of your equity. There are lots of things I have not covered- taxes, 409 valuation, liquidity, etc. so you would want to consult with experts before making decisions but hopefully this is helpful as a starting point.

Valuing very early stage startups or concepts is part art, part science. One method is the Valuation Scorecard. 📈 Let's delve into it - just one tool in the toolkit that can help assess the potential of early-stage companies, especially those without substantial revenues or much of an operating history. The method offers a structured approach to evaluate startups by comparing them to similar companies that have already been priced by the market. It's a helpful complement to valuation models like DCF, multiples or Berkus. The Scorecard typically encompasses several criteria: Management Team (25-35%): Caliber, experience, and track record of the startup's management team. Strong teams can lead, pivot and adapt. Market Size (10-30%): Potential market size of the product/service indicates the potential. Larger markets = greater opportunities but often come with increased competition. Product/Tech (10-25%): Uniqueness and defensibility of the product/tech. Innovative solutions (with IP) can be significant value drivers. Competitive Environment (10-20%): Level of competition within industry impacts a startup's ability to capture market share. Sales Channels (10-20%): Effective go-to-market strategies and sales channels. Product channel fit. Follow-on Investment (5-15%): Heavy future funding requirements to reach positive cash flow affects the risk profile and dilution of current investments. Other (5-10%): Includes any other relevant factors specific to the industry or business model. Crafting the Scorecard 1. Benchmarking: Identify a group of comparable startups that have recently been valued. Benchmarks should be as close as possible in terms of industry, stage, market. 2. Weights: Allocate weights to each criterion based on importance in the specific context of the startup. Industry trends and specific business model considerations play a role. 3. Scoring: Rate the startup against each criterion using the benchmarks as a reference. Scoring should be as objective as possible, ideally involving inputs from multiple evaluators to mitigate biases. 4. Calculating the Valuation: Determine an average valuation from the benchmarks and adjust it based on the startup's scores. Adjusted valuation provides a more nuanced view of the startup's worth, considering its unique strengths and weaknesses. Art or Science? The Scorecard Method brings structure and comparability to startup valuations, but it's not foolproof. Even in an era of massive data, the dynamic nature of startups mean that qualitative judgments and investor intuition still play a significant role. What are your tips for a good scorecard? 💡

I have been building Valuation Models for 18 years! Some key points that I have learnt along the way.. Try these to improve your analysis significantly! ✅ Always understand the business before approaching valuation. This will form the core of your valuation model assumptions. - What does the company do? - How does it make money - What is the value chain? - Are their any competitive advantages that it has? ✅ Check for the financials. - Pick out annual reports, Punch in the data for last 4-5 years, and calculate ratios - Look at all major numbers and find out what they are. Other expenses are large - check what they are. Provisions in Balance Sheet are large - check them. - Look for trends in numbers and ratios - Are margins increasing, decreasing, or constant. Is working capital cycle moving around? Any other trends worth noticing? - Why are these happening? Try and identify what are the key reasons ✅ Projections - Project financials. Build a completely linked valuation model. - Whether you are doing DCF, or Relative Valuation - it is good to get a sense of how projected financials would look like. - The Balance sheet should link completely and the model should be dynamic. The model is NOT COMPLETE without this. - If you change assumptions - it should flow cleanly and the Balance Sheet should remain balanced ✅ Valuation - This comes last. Choose the appropriate method - FCFE, FCFF, Relative Valuation, SOTP. If not sure, try more than one method - Focus on the business. You can do a sensitivity on the discount rate, but it is usually difficult to do that on the business. - It is ok to be uncertain about the final price you get. But you need to know the relationship between business parameters like volume / pricing / costs and the valuation Learning Valuation Modeling is a process. Key is to keep practising and reading on the business. Try this the next time you are building a valuation model. ----- I help people build a #career in #valuation and #investmentbanking through my writing and courses. Follow me (Peeyush Chitlangia, CFA) to stay tuned for future posts.