The Venture Capital Method (VC Method) by simplified example Post-Money and Pre-Money valuations

There are many ways to evaluate or estimate the value of a business namely:

-         Net asset values ("NAV")

-         Comparative Multiples ("Comps")

-         Discounted Cash Flow ("DCF")

When the company is not making any money or even losing money, despite a brilliant idea, would you use NAV, Comps, DCF to assess its value?

“NO”. You better use the Venture Capital Method (VC Method).

How do you perform it?

Very simple 4-steps:

-         First, identify at ‘at risk’ money an investor is providing in the round

-         Second, total equity stake (%) the investor wants

-         Third, divide investment by shareholding to give Post money valuation ‘implied’ by terms

-         And fourth, subtract total at-risk money to give pre-money valuation

To onboard new investors, founders can use a different kind of instruments namely:

Source: Alpha Capital Investment

All these instruments may be used by the founders to avoid dilution. However, we do think that 10% of 100m$ (= 10m$), is better than 55% of 10m$ (=5.5m$).

Illustration by a simple example with 3 rounds of financing

The situation

Round 1: Startup in 2010

-         In 2010, Mr. Albert The Great started BlueBird & Co a business specialized in real estate investment with 250,000 USD sourced from his savings, family and very good friends.

-         At inception, the company had 250,000 shares (ordinary shares). 

Round 2: Cash shortage in 2012

-         Due to a poor economic situation, the projected turnover did not realize, and Albert has faced a cash crisis and needed free cash to avoid going burst

-         Alpha Capital a Venture Capital Fund led by John Meyer an experienced and respected investor believed in this business and decided to invest cash for ordinary shares

-         John invested 500,000$ for 750,000 new common shares

Round 3: Business development abroad in 2015

-         With the fresh money and the assistance of John, the business multiplied its turnover by 10 (ten) within 3 years end needed new money to finance its development abroad

-         Thanks to the company’s performances and John’s network, BlueBird & Co attracted Beta Partners a Private Equity Fund led by Victoria Li a Rainmaker and Successful business women.

-         Victoria invested 10,000,000 USD for 500,000 for common shares

Now the question is to calculate Pre-Money, Post-Money and Value creation (if any) throughout the rounds.

Solutions

Comments:

First round in 2010:

• Nothing needs to be said for the first round (startup).

Second round in 2012:

• For the second round in December 2012, we can notice the value destruction of -83,333 USD which is mainly due to the cash crisis.
• Also, there is a huge dilution of the ownership of the founders. Indeed, it decreases from 100% to 25%.
• 25% of something remains better than 100% of nothing! They still have 166,667 USD in value.

Third round in 2015:

• Thanks to many positive factors (financial performance, positive perspectives, and strong network), the company created around 19.3m$ (USD)
• Despite another dilution for both existing owners (Founders and Alpha Capital VC), founders’ shares value stood at 5m$ (USD) from 167k$ at the previous round.
• Also, the per share value soared from 0.67$ to 20$

Conclusion:

- This is a simplified application of the VC method for illustration. Nevertheless, it gives a clear illustration of this method

- The VC method is used for “new venture”

- The situation and perspectives drive the value of a business in general and in the VC method in particular

- The dilution could be a solution in a “tough” situation namely cash crisis

Author: Mr. Abraham Mboyo, MRICS | CEO at Alpha Capital Investment (www.alphacapinvest.com)