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💡 Before we dive into the different levers, let’s broadly touch some valuation basics.
In order to give you some actionable advice (and not bore you to death), we don’t cover every last detail of valuation theory.
The resource section is a good starting point for those who are interested in learning more. Future templates will branch out into more details as well.
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💡 #1 Intrinsic and relative value → 2 Methods is all you need
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💡 Ultimately, there are dozens of valuation models but only two valuation approaches that really matter and that you/your investor can use to value your company: intrinsic and relative
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- In intrinsic valuation, we begin with a simple proposition: The intrinsic value of an asset is determined by the cash flows you expect that asset to generate over its life and how uncertain you feel about these cash flows. Assets with high and stable cash flows should be worth more than assets with low and volatile cash flows.
- In relative valuation, assets are valued by looking at how the market prices similar assets. Thus, when determining what to pay for a house, you would look at what similar houses in the neighborhood sold for. With a company, that means comparing its pricing to similar companies, usually in its “peer group.”
- While there are purists in each camp who argue that the other approach is useless, there is middle ground:
- Intrinsic valuation provides a fuller picture of what drives the value of a business, but there are times when a relative valuation will yield a more realistic estimate of value.
- In general, there is no reason to choose one over the other, since nothing stops you or your investor from using both approaches on the same investment (your company, remember?)
💡 #2 Uncertainty → Keep it simple!
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💡 Most valuations (even good ones) are wrong.
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- Collecting more information and doing more analysis will not necessarily translate into less uncertainty → In some cases, ironically, it can generate more uncertainty.
- When valuing your company or trying to make sense of a valuation presented to you by an investor, don’t be overwhelmed by all the fancy words and techniques ⤵️
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💡 Understand: Valuation is simple, we just choose to make it complicated → Use the simplest model that you can!
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- If you can value your company with three inputs, don’t use five.
- If you can value your company with three years of forecasting, forecasting 10 years of cash flows is asking for trouble. Less is more!
💡 #3 Key Levers → Know where to push
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💡 Broadly speaking, there are only a few main inputs that feed into a valuation either intrinsic or relative, hence impact the value of your business. We will cover the gist of it down below, so you start to get a feeling for the different levers of value.
Let’s check out what each means down below ⤵️
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1. Business Plan - Who / What / How / When
- One of the first things an investor wants to see is your business plan because it usually answers 80-90% of all his questions for valuing your company.
- Providing an investor with a solid and plausible business plan (that also has some numbers in it) is a big plus when it comes to valuation.
- It shows that you have done your homework and know where you are heading and how you can get there.
- A business plan (in a nutshell) states how, with what means and with whom you plan on making money off your idea. It consists of a few key components:
- Customers - The market you are focusing on and the adjacent markets to conquer, a TAM - total addressable market, is usually a good first indicator here.
- Product/Price - With what products and what price do you plan on nurturing your top line, and how will these two develop over time?
- Revenue - A rough estimate of how much revenue you will be able to generate in the coming years, based on the chosen market and product/price above, as well as other factors like conversion and churn rates.
- Competition and USP - Who are you competing against, and how do you plan on outperforming them, e.g. what makes your business special or hard to copy?
- Costs and Investments - How much money do you need to deliver and scale your product, from a small garage operation, into a calm and sustainable business?
- Operations & Technology - How do you run your company, both from an operational and technical side? Is it semi-/fully automated, or does it require a lot of manual labor?
- Scalability - How easy/hard is it going to be to scale your operations from a technical, operational and financial standpoint?
- Story and Narrative - What is the overarching narrative of your business model and the company as a whole? We humans not only use stories to reduce the surrounding chaos - but in investing we also use a solid narrative to power main inputs for valuations like revenues, profitability and growth.
- Management and Key Players - Who are your top people, what makes them special, and how do they get the job done?