Business Valuation of Start-Up Companies. Is Discounted Cash Flow the Best Method to Value a Start-up Company?

Contents

List of Abbreviations

Bibliography

1. Introduction to the subject
1.1. The purpose of the term paper:
1.2. The key question is:

2. Theoretic basics of business valuation and start-ups
2.1. Basics of Business Valuation
2.1.1. Dimensions of Business Valuation
2.1.2. Approaches of The Business Valuation
2.2. Basics of Start-Ups
2.2.1. Definition of a Start-Up
2.2.2. Development Phases of a Start-Up
2.2.3. Business Valuation of Start-Ups
2.2.3.1. Importance of Start-Ups Business Valuation
2.2.3.2. Criteria of Start-Ups Business Valuation

3. Business Valuation Methods
3.1. The Market Multiple Method.
3.2. Venture Capital Method
3.3. The Development Stage
3.4. Discounted Cash Flow

4. Choosing the Business Valuation Method for LANO

5. Conclusion

Attachment List

Attachment

List of Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

Bibliography

- Baier, W., & Pleschak, F. (1996). Finanzierung junger Technologieunternehmen. In Marketing und Finanzierung junger Technologieunternehmen (pp. 101-166). Gabler Verlag.

- Bandulet, F. (2015). Finanzierung technologieorientierter Unternehmensgrundungen: wirtschaftshistorische und institutionenokonomische Erklarungsansatze von Schumpeter bis Williamson. Springer-Verlag.

- Damodaran, A. (2009). Valuing young, start-up and growth companies: estimation issues and valuation challenges. Available atSSRN1418687.

- Fazzini, M. (2018). Business Valuation: Theory and Practice. Springer.

- Festel, G., Wuermseher, M., & Cattaneo, G. (2013). Valuation of early stage high- tech start-up companies. International Journal of Business, 18 (3), 216.

- Ghanbari, A., Hoseini, S., Esfanjani, H. (2019). Designing a Valuation Model for Petroleum Startups. International Journal of Finance and Managerial Accounting, Vol.3, No.12, Winter 2019

- Hahn, C., & Naumann, D. (2014). Finanzierung und besteuerung von start-up- unternehmen. Praxisbuch fur erfolgreiche Grunder, Wiesbaden: Springer.

- Hayn, M. (2003). Bewertung junger Unternehmen. Verlag Neue Wirtschafts-Briefe.

- Matschke, M. J., Brosel, G., & Matschke, X. (2010). Fundamentals of functional business valuation. Journal of Business Valuation and Economic Loss Analysis, 5 (1).

- Heesen, B. (2018). Basiswissen Unternehmensbewertung. Springer.

- Matschke, M. J. (2013). Funktionale Unternehmungsbewertung: Band II, Der Arbitriumwert der Unternehmung. Springer-Verlag.

- Kotova, M. V. (2013). The theoretical and methodological basis of startups valuation. EkOHOMika: peajiii uacy, (1 (11), 2014), 107-112.

- McClure, B., “Valuing Start-Up Ventures.” Investopedia, https://www.investopedia.com/articles/financial-theory/11/valuing-startup- ventures.asp#ixzz1X7XuhAVo (2019)

- Nathusius, K. (2001). Grundlagen der Grundungsfinanzierung: Instrumente- Prozesse-Beispiele. Springer-Verlag.

- Nylen, M., Pettersen, R. (2017). Which valuation method yields the most accurate value in the valuation of companies in different stages of their life cycle. Master Thesis.

- Pepis, S., Evans, J., & de Jong, P. (2018). The Valuation of Startups in New Markets: an Applied Case in Asteroid Mining. International Journal of Business and Social Science, 9 (4).

- Sabina, J. A., & Irina, A. I. (2010). A survey on business evaluation methods used in mergers. Annals of Faculty of Economics, 1 (2), 878-884.

- Ullah, G. W., Parvez, S., Ahmed, S. U., & Mahtab, F. (2018). VALUATION OF STARTUP FIRMS: A CASE STUDY ON PATHAO. Independent Business Review, 11 (1/2), 19-28.

1. Introduction to the Subject

It is important when someone wants to buy something that he knows its value and that he is sure that he has not paid more than its real value. It is relatively easy to know the value of the things we buy in a daily basis by comparing the price to other things or when comparing the current price to the price in the past.

However, the situation is quite different when we buy a company with all its departments and knowledge. Here we will have to use some specialized methods to be able to know the value closest to reality and to avoid significant material losses when an evaluation error occurs.¹

Business Valuation is one of the most difficult challenges in business. The reason is that we live nowadays in an extremely changing world. That makes it difficult to measure the valuation of a company and expect their development for the next years.² It is also much more difficult and trickier to value a Start-Up company due to the lack of important information about new companies such as corporate governance mechanisms. Therefore, the valuation process of Start-Up Companies looks a little bit different from the valuation of normal companies.³

1.1. The Purpose of the Term Paper:

The purpose of this term paper is to study the different methods and criteria of the Business valuation of companies and comparing them and check their applicability to Start-Ups. The difference between the valuation of normal and new companies should be also illustrated.

This will be approached with the help of specialist literature, journals and magazines. The practical part will be illustrated by the practical process of choosing the best possible business valuation method of an early fintech Start-Up in Germany.

1.2. The key question is:

Is Discounted Cash Flow the best method to value a Start-Up Company?

2. Theoretic Basics of Business Valuation and Start-Ups

2.1. Basics of Business Valuation

2.1.1. Dimensions of Business Valuation

There are three dimensions of Business Valuation. Firstly, the objective dimension is by valuing a company using traditional specialized methods. This dimension will look only on the real value and compare it with the market price.⁴ The main concentration of this dimension is on the “Independence of the appraiser.”⁵

Secondly, the subjective dimension is when someone values a company in accordance with the experience and point of view and needs of the buyer and seller. The risk behind this dimension is that the valuation come only from one side and there is enough room for mistakes and misunderstandings.⁶ It is very important to rely on the objective evaluation in the most cases using specialist methods. However, in case of lack of information about a company such as Start-Ups⁷, it is important to evaluate the company according to our view of the situation in general using the subjective dimension and not just rely fully on the numbers.⁸

Thirdly, as a middle solution between these two dimensions there is the functional Dimension (Functional Theory). The valuation in this theory considers both dimensions the objective and the subjective one. The purpose of the business valuation is the most important aspect in this theory and every business valuation should be made according to its purpose.⁹

2.1.2. Approaches of The Business Valuation

Recently, emphasis has been placed on evaluating companies on methods that evaluate quantity without considering other factors that are also important. When evaluating a company, all factors that directly or indirectly affect the company must be tested. Otherwise there would be a room for under- or overvaluation. That was the traditional approach of the most textbooks of the business valuation. To be able to avoid such under- or overvaluation of the traditional approach, all the aspects that play a role in the target company should be analyzed from both sides qualitatively or quantitatively.¹⁰

“Evaluation means translating into quantitative terms a set of qualitative elements based on certain strategic choices.”¹¹

That is the definition of the integrated approach “IVA” which contains a set of processes that have to be done one after another to get the most out of the business valuation. This approach is based on three processes:

1- An investigation of the internal and external components of the company.
2- An examination of the consistency of the value of the target company.
3- Determining the suitable business valuation method.¹²

2.2. Basics of Start-Ups

2.2.1. Definition of a Start-Up

Start-Ups are younger than ten years with an innovative service or product and have a potential for growth. In this way described the Deutsche Start-Up Monitor the characteristics of Start-Up companies in 2017.¹³ Hahn defines Start-Ups as a young company in its beginning stages regardless of its product or service looking for funding medium to expand its capabilities and innovation.¹⁴

2.2.2. Development Phases of a Start-Up

There are five development phases for Start-Up companies:

Everything begins with the seed phase, when the entrepreneur has an innovative idea and attempts to collect all the information related to the market and the idea. He will need this information to write his business plan in order to be able to attract investors and get the funding medium.¹⁵ The next phase is the start-up Phase, when the company starts giving a value to its customers and/or realizes its first sales. Then with the growth phase the sales and user number will grow a lot faster than the last phase.

When the start-up survives all these first three phases, it will move to the later phase. In this phase the start-up will be an established market participant and it is essential to continue financing the company to be able to move quickly to the next phase.¹⁶ It is also normal in this phase for the start-up not to make profit because it pays much more for growth as it deposits from sales.¹⁷ It comes to the point, when the sales and the user number of the start-up start falling down. This is an indicator that the company reached the last phase which is the steady phase.¹⁸ In this phase there is a need to diversify and develop the product of the start-up and find new markets for them.¹⁹

2.2.3. Business Valuation of Start-Ups

2.2.3.1. Importance of Start-Ups Business Valuation

A recent research by Small Biz Trends shows that about 90% of start-ups fail.²⁰ Another recent study shows that 50% of start-ups survive five years or more, 33% survive ten years or more and 20% of them fail in their first year.²¹

Such studies could be taken as an evidence that there is a high probability that start-ups will fail and just a few of them will make it to the end. The above information can also be proved by the following study, which states that the percentage of corporate investments in the seed phase of start-ups is 24% in 2018 in comparison with the percentage of the corporate investments in the next phase (Early Phase) which is 54%. The study shows also that, while early and later stage investments have risen the most in 2018, seed investments have stagnated in the last three years. Deutsche Telekom AG is one of the German corporate companies who followed this trend.²²

From these studies we can find out that the evaluation of start-ups and the study of the possible and best methods of the evaluation are essential for corporate companies because with these methods they will be able to get a wider view of the target company and that will therefore reduce the chances of financial losses at the end.

2.2.3.2. Criteria of Start-Ups Business Valuation

Abbildung in dieser Leseprobe nicht enthalten

International Journal of Finance and Managerial Accounting, Vol.3, No.12, Winter 2019, S.97

While investors can depend in their business evaluation process on the corporate governance mechanisms to get trustworthy information about the target company, it seems difficult when the target company is a start-up and has a very short history.²³

So, it would be of importance to have some criteria that help the investors by taking their decision. One of the criteria that influence the evaluation is the financial numbers when they are available, then the personality and the characteristics (human- and social capabilities) of the founders of the target start-up and their attitude. Another criteria for the evaluation is which marketing strategy have been used in the start-up. An important one also is the entrepreneur's ability to survive against the different problems that face him.²⁴

3. Business Valuation Methods

There are lots of methods of valuation and every author has structured them in different ways. Some of them preferred the one over another as Heesen for example, who states that the Discounted Cash Flow is the most used method in the entire world. He states also that the market multiple method cannot be used alone to evaluate a company due to the fact that there are no comparable companies.²⁵

In contrast Fazzini said that the market multiple method has been used the most after the financial crisis comparing it to DCF method which has been used the most between 1990 and 2000.²⁶ A survey of business valuation from 2005 proved the statement of Fazzini by reporting that 99% of analysts use multiple method.²⁷

[...]

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¹ Cf. Fazzini, “Business Valuation.” (2018): P. 1-2

² Cf. Fazzini, “Business Valuation.” (2018): P. 2-3

³ Cf. Festel, Wuermseher, Cattaneo, “International Journal of Business.” (2013): P. 220

⁴ Cf. Fazzini, "Business Valuation.” (2018): P. 8

⁵ Matschke, Jurgen, Brosel, "Fundamentals of Functional Business Valuation.” (2008): P. 9

⁶ Cf. Jurgen, Brosel "Fundamentals of Functional Business Valuation.” (2008): P. 9

⁷ Cf. Cf. Festel, Wuermseher, Cattaneo, "International Journal of Business.” (2013): P. 220

⁸ Cf. Fazzini, "Business Valuation.” (2018): P. 8

⁹ Cf. Matschke, „Funktionale Unternehmensbewertung." (2013): P.31; Hayn, „Bewerung Junger Unternehmen." (2003): P: 38

¹⁰ Cf. Fazzini, “Business Valuation.” (2018): P. 23-24

¹¹ Fazzini, “Business Valuation.” (2018): P. 24

¹² Cf. Fazzini, “Business Valuation.” (2018): P. 25

¹³ Cf. Attachment 1

¹⁴ Cf. Hahn, Naumann, „Finanzierung und Besteuerung von Start-Up Unternehmen.“ (2014): P. 4

¹⁵ Cf. Bandulet, „Finanzierung Technologieorientierter Unternehmesgrundungen." (2005): P. 11

¹⁶ Cf. Attachment 2

¹⁷ Cf. Nathusius, "Grundlagen der Grundungsfinanzierung.” (2001): P. 59; Bandulet, „Finanzierung Technologieorientierter Unternehmesgrundungen." (2005): P. 11

¹⁸ Cf. Attachmaent 2

¹⁹ Cf. Baier, Pleschak, “Finanzierung Junger Technologieunternehmen.“ (1996), P. 39; Bandulet, „Finanzierung Technologieorientierter Unternehmesgrundungen.“ (2005): P. 11

²⁰ Cf. Attachment 3

²¹ Cf. Attachment 4

²² Cf. Attachment 5

²³ Cf. Festel, Wuermseher, Cattaneo, “International Journal of Business.” (2013): P. 219

²⁴ Cf. Festel, Wuermseher, Cattaneo, “International Journal of Business.” (2013): P. 219

²⁵ Cf. Heesen, “Basiswissen Unternehmensbewertung.” (2018): P. 5-16

²⁶ Cf. Fazzini, “Business Valuation.” (2018): P. 36-37

²⁷ Cf. Sabina, Irina, “Survey of Business Valuation Methods.” (2010): P. 881