February 2022
The valuation of a start-up business is one of the most difficult valuation assignments in that there isn’t any relevant historical financial information to use in predicting future revenues or cash flow. However, reasonable values can be determined for start-up businesses by carefully analyzing the financial information that does exist, examining industry data and interviewing management as to revenue and cash flow expectations and the corresponding risk of achieving those expectations.
One common method in valuing a start-up business is to analyze arm’s-length transactions in the business’ equity. If there have been arm’s-length transactions in the business’ equity, the transaction prices can be used to value the subject interest, after adjusting for changes in the business since the date of the transactions.
Another common method in valuing a start-up business is to either utilize financial projections prepared by management, or make projections in preparing a discounted cash flow valuation (“DCF”). Future net cash flows are derived from the financial projections and discounted to present value at an appropriate rate. In determining the appropriate discount rate, the risk of achieving the projections can be estimated by having conversations with Management, analyzing industry data and by looking at discount rates of comparable companies. Benchmarks can be used as a starting point in estimating a reasonable discount rate. For instance, it has been reported that the venture capital target rate of return for start-up businesses is 50% to 70%. Of course, the appropriate discount rate depends on the facts and circumstances of the particular case.
A method used by venture capital firms in valuing a start-up business is to estimate the value of the business at their exit point and then discount the result to present value. The exit point is typically the date when an IPO is anticipated. The value at that point is normally derived by looking at publicly-traded market multiples of businesses in the same industry.
Whatever method is used to value the start-up business, a wide range in values is possible due to the subjective nature of assessing risk. The key is to estimate cash flows and level of risk that both a seller and a buyer could agree upon. The estimated cash flows and risk level then lead to a value that both a seller and a buyer could agree upon.
Relevant Court Cases
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Cain v. Cain,
Nebraska Court of Appeals,
A-21-068,
filed February 1, 2022
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Signature Industrial Services, LLC v.
International Paper Company,
Supreme Court of Texas,
No. 20-0396,
filed January 14, 2022
Recent Business Valuation Articles
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“Applied Economic Theory in the Law:
Present Value Discount Rate Calculation in Legal Valuations,”
by Peter C. Dawson,
posted February 1, 2022
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“Earnings Versus Cash Flows in Equity
Valuation: Evidence from the COVID-19
Crisis,”
by Jeong-Bon Kim, Junwoo Kim and
Jay Junghun Lee,
posted January 30, 2022
Recent Engagements
- Valuation of a 50% member interest in a mostly real
estate holding company on a non-controlling
interest basis for gift tax reporting purposes.
- Valuation of the common stock of a communication service
provider on a minority interest basis for estate tax reporting
purposes.
- Valuation of member interests in a specialty service firm
on a minority interest basis for gift tax reporting/sale
purposes.
- Consulting regarding the fair market value of 100% of
the common stock of a niche engineering consulting firm,
on a controlling interest basis, for potential sale purposes.
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