Anilesh Seth

Ideator, Co Founder & CEO, KROW

www.krow.in

Strategic Advisor to the Qatalys Group of Companies

Mentor at the KYRON incubator

Visiting Faculty at CMR IT Exec MBA program

Ex-CEO/MD: LGSI, Qatalys & Supervalu India

www.slideshare.net/anilesh

http://In.linkedin.com/in/anileshseth

anileshseth@hotmail.com

Some fundamentals first: The time value of money

• A certain amount of money available today is worth more than the same amount available in the future

• This is because the money available today can earn interest – hence money is worth more, the sooner it is received

• If you had to make a choice to collect a Rs 100,000 lottery that you won, today, or two years from now, which would you choose?

Some fundamentals first: Present and Future Value of money

• Let’s say you are going to invest 10,000 today @10% interest per year

• The future value of this investment is FV1= 10,000*(1+10%) = 11,000 • At the end of the second year this will be worth FV2 =

11,000*(1+10%) = 12,100 • Or FV2 = 10,000*(1+10%)*(1+10%) • Or FV2= 10,000*(1+10%)^2 • The general equation is : FVn = PVn*(1+i)^n • Conversely, to find the Present Value we would use the

equation: PVn = FVn/((1+i)^n)

Some fundamentals first: Discounted Cash Flow (DCF)

• DCF is at the core of arriving at company valuation, based upon expected future cash flows

• We would need to obtain the present value of each of the future cash flows

• To do so we need to “discount” each such cash flow to the present

• The discount rate to be applied would ideally be the WACC or the weighted average cost of capital – which is nothing but a blend of the cost of equity and debt

• For a start up this is more an “art” than a science! • An investor who is seeking a 10 times return in 5 years may

want you to pass the 59% discount rate test!

Example of a DCF calculation

All monetary figures in rupees

DISCOUNT RATE 30.00%

Year 1 Year 2 Year 3 Year 4 Year 5

NET CASH FLOW 10,00,000 50,00,000 1,50,00,000 5,00,00,000 10,00,000

Year 1 discounted 7,69,231

Year 2 discounted 29,58,580

Year 3 discounted 68,27,492

Year 4 discounted 1,75,06,390

Year 5 discounted 2,69,329

TOTAL=PV 2,83,31,022

Or use the formula =NPV(rate, VAL1, 2) 2,83,31,022

Remember that the general formula for PV of a future cash flow is PVn=FVn/(1+i)^n

Remember to discount each cash flow to the present and then add them all up

Raising money

• Beauty, like Value is in the eyes of the beholder!

• Yet we still need to arrive at some value for our start up if we want to raise money

• There are many methods of arriving at value – at the end of the day these are ranges that you use to negotiate

• Some methods that are employed are: DCF, Asset Based, Proxy Based (based upon industry averages), Cost-plus based

Example of a start up: projected cash flows of a B2C start up: How much to raise and how much to dilute?

ALL MONETARY FIGURES IN RUPEES

YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5

TOTAL REVENUE - - - 9,55,000 2,61,03,198 15,62,84,806 43,32,45,539 1,20,03,90,883

EXPENSES SUMMARY

PHONE/MOBILE DATACARDS 1,59,930 17,85,500 22,88,500 28,89,400 34,27,900

Rentals/Maintenance/DG/Housekeeping/Security/Utilities/Supplies/Refreshments4,59,000 24,33,600 25,41,600 94,26,000 96,04,200

Hiring/Training/Payroll 2,55,357 30,53,152 23,84,969 36,35,409 34,94,305

Travel Costs 1,94,000 34,92,000 97,92,000 2,35,08,000 3,53,52,000

Legal costs 8,00,000 40,95,525 1,27,350 3,15,075 1,12,700

TOTAL IT COSTS 2,88,600 26,50,650 38,21,950 55,97,550 77,04,600

MARKETING COSTS 18,03,125 4,59,18,000 8,58,27,450 8,81,99,287 11,92,51,665

MANPOWER COSTS 59,75,000 2,95,99,599 3,60,49,567 4,23,01,733 4,83,30,466

OTHERS 1,00,000 10,00,000 15,00,000 20,00,000 30,00,000

DEPRECIATION 1,26,667 11,20,333 31,77,000 42,15,333 53,77,000

- - - - - -

TOTAL EXPENSES 1,01,61,679 9,51,48,360 14,75,10,386 18,20,87,787 23,56,54,837

CASH FLOWS

NET PROFIT/LOSS -92,06,679 -6,90,45,162 87,74,420 25,11,57,753 96,47,36,047

ADD DEPRECITION 1,26,667 11,20,333 31,77,000 42,15,333 53,77,000

LESS CAPEX 6,00,000 31,05,000 94,70,000 38,15,000 65,40,000

LESS DEPOSITS 2,16,000 9,09,000 - 34,11,000 -

TOTAL CASH NEEDED -98,96,012 -7,19,38,829 24,81,420 24,81,47,086 96,35,73,047

Analysis

• How much money is required for Year 1? Should we raise more than that amount? If yes, how much more?

• Considerations:

– Present valuation and therefore dilution

– Lead time required to raise money in the future: don’t forget your “burn rate” will be increasing

Some more terms

• What is pre-money valuation? Simply put, this is the value of your firm before you have raised money. Lets say based upon future cash flows your firm valuation is Rs 10 crore. This is pre-money valuation – or the value BEFORE you have infused money from your investors • What is post-money valuation? This is nothing but the pre-money valuation plus the funding amount that you are seeking. So in the above example if you are raising Rs 1 crore then your post=money valuation is Rs 10 crore plus Rs 1 crore = Rs 11 crores

Some more terms

• What is dilution? This is the amount of control you would be giving away in terms of stock, when you raise money. Remember that Pre-Money dilution and Post-Money dilution is not the same • In the previous example, the pre-money value is Rs 10

crore. If you are raising 1 crore, and you agree to a pre-money dilution, then the value of your enteprise AFTER funding is deemed to be Rs 10 crore out of which you are giving away 1 crore worth or 10%.

• However if you agree to give away stock on a post-money valuation basis then the value of your company is Rs 11 crores and you are giving away 1/11 = 9.09%

Some more terms

• Do we assume that after 5 years the company ceases to operate? We can’t do that…

• But we can assume that it will settle down to a lower growth rate that reflects its maturity over time

• Hence in the fifth year we should compute a “terminal value” of the company that is reflective of its future cash flows – albeit at the lower growth rate. This terminal value too needs to be discounted to the present and added to the present value to arrive at the true enterprise value

• The general formula for this is:

Final projected year cash flow * (1 + long term cash flow growth rate)/(Discount rate – long term cash flow growth rate)

OK…back to our example

• Without worrying about the added complexity (tho strictly speaking required) of the terminal value, the Present Value of the cash flows projected over 5 years is: – At a discount rate of 20%: About Rs 45 Crores – At a discount rate of 30%: About Rs 29 Crores – At a discount rate of 40%: About Rs 20 Crores – At a discount rate of 59%: About Rs 10 Crores

• Remember, if we had used the terminal value also, these figures would be higher

• Assuming a valuation of 20 Crores has been agreed with the prospective investor, this is the Pre-money valueation of the company

• If you are raising Rs 1.5 Crores at this stage, your Post-money valuation would be 21.5 Crores and you would be diluting 1.5/21.5 or roughly 7% of your company

Illustration of how value accrues

• Here is a simplified example of how value accrues as the founders dilute more over time to raise cash. This is purely illustrative and simplified to show dilution on the part of the founders only, in each subsequent round…

Stage Timeline Value Funding Post Money Dilution (%) Founders Stake Founders Value

Idea/Formation 1 Yr Ago 10,00,000 0% 100.000% 10,00,000

POC/Angel Now 5,00,00,000 50,00,000 5,50,00,000 9.091% 90.909% 5,00,00,000

Series A 1 Yr Later 22,00,00,000 8,00,00,000 30,00,00,000 26.667% 64.242% 19,27,27,273

Series B 2 Yrs Later 1,50,00,00,000 30,00,00,000 1,80,00,00,000 16.667% 47.576% 85,63,63,636

Founders holding % decreases

Founders holding value increases

TIME

In rupees

OK – now onto a quick treatise on other methods of valuation

• Asset based: Net tangible book value: – All tangible assets (like cash, WDV of assets, accounts receivable, etc) minus all

liabilities and debt

• Revenue multiple: X * Revenue • Earnings multiple: X * EBITDA

– Use the average industry profitability as a proxy/indicator

• Cost plus: Sometimes a start up will arrive at a valuation based upon the market value of the effort they have put in plus a premium on the idea/product that they have created

The problem with valuing a start up is that you have no history to show. Hence investors will talk about the management team, the “traction” gained, entry barriers patentable idea that you may have , recent valuations in similar cases etc…. All the valuation techniques enable you to write down indicative ranges based upon different approaches/industry proxies and provide both you and the investor a starting point To negotiate…. Remember that an idea is as good as its execution – and hence the importance of the management team…

Examples of how value accrues

Company redBus

Launched August 2006

Capital Rs. 5,00,000

Feb 2007 First round

$1 million Seed Fund and undisclosed investors. •$500,000 - Seed Fund. •$500,000 - other investors

July 2009 Second round

$2.5 million - Inventus Capital Partners, Seed Fund and other unnamed investors

May 2011 Third round

$6.5 million - Helion Venture Partners, Inventus Capital and Seedfund

March 2013 •Net revenues -Rs 55 crore •Expected to post a net profit of around Rs 2 crore for FY13.

June 21, 2013 Ibibo Group acquires redBus at an estimated $100 million (about Rs 600 crore).

Company Flipkart

Founded 2007

Capital Rs. 4,00,000: Sachin Bansal and Binny Bansal

2009

1st round

$1 million: Accel India

•Assume 15% stake sale at $6.6m valuation. Promoter +

Employees = 85% | Investors = 15%

2010

2nd round

$10 million : Tiger Global.

•Assume 30% stake sale at $33m valuation. Promoters

+ Employees = 59.5% | Investors = 40.5%

June 2011

3rd round

$20 million: Tiger Global.

•Assume 25% stake sale at $80m valuation. Promoters

+ Employees = 44.625% | Investors = 55.475%

Company Flipkart

August 2012 4th round

$150 million : MIH (part of Naspers Group) and ICONIQ Capital. •Assume stake sale of 15% at $1b valuation. Promoters + Employees = 37.93% | Investors = 62.07%

10 July 2013 5th round

$200 million: Existing investors including Tiger Global, Naspers, Accel Partners and Iconiq Capital. •Assume stake sale of 17% at $1.2b valuation. Promoters + Employees = 31.48% | Investors = 68.52%

Oct 10, 2013 $100million: • Additional 160 million funding announced

Thank you!