By Chris Droussiotis
In one of the numerous conferences I attended in Cyprus, I engaged in an enlightening conversation with a proud scientist and inventor about how I could assist him in commercialising his innovative product. After showcasing his remarkable creation, I posed a fundamental question: “What do you believe your invention is worth?” His response was immediate and emphatic: “Priceless.” At that moment, I realised I already knew the answer before I asked it; it was akin to asking a parent the worth of their newborn child.
When evaluating investment opportunities, analysts often delve into the intricacies of risk assessment and business valuation, constructing detailed spreadsheets to quantify potential returns.
However, determining the worth of a company or an investor’s equity is inherently subjective. Valuation involves a significant amount of interpretation regarding the data employed in various methodologies. It is a delicate balance of art and science, where the selection of data involves a degree of judgment. Buyers and sellers inevitably possess differing perspectives, leading to varying valuation conclusions. Ultimately, the true value of an asset is defined by what someone is willing to pay for it.
The limitations of traditional valuation methods become glaringly apparent when examining financial history. For instance, how can one explain the stratospheric rise in stock prices for numerous tech companies that posted negative income and cash flows during their formative years, such as Amazon or Facebook? Consider the US fintech company Venmo, which raised $1.5 million in seed funding and was subsequently acquired by PayPal for a staggering $800 million in under three years.
A crucial insight is that a valuation devoid of a compelling narrative often falls flat. People are far more likely to remember stories than spreadsheets. Successful investors frequently embrace an expansive view beyond conventional valuation techniques, integrating innovative metrics into their assessments. This approach creates a hybrid model that fuses traditional valuation methodologies with the power of storytelling.
So, how are new ideas valued? What metrics are utilised to determine the worth of intellectual property, brand names, franchises, trademarks, or innovative startups? Valuing intellectual property is increasingly essential given the rapid expansion of new technological platforms, including FinTech, CleanTech, HealthTech and EduTech. It is no coincidence that the largest companies by market capitalisation – such as Apple, Amazon, Google, Nvidia and Microsoft – are predominantly technology firms. All five began their journeys with captivating narratives that resonated with their audiences. A compelling story is characterised by its simplicity, credibility and persuasive power.
One of our early success stories at Kinisis Ventures is Threedium. In April 2017, two ambitious tech enthusiasts from Cyprus, fresh out of university, envisioned bridging the gap between online and in-store experiences through a 3D solution. Their goal was to enhance customers’ understanding and evaluation of products they were considering for purchase.
Like many small startups with grand aspirations, securing early funding and expert collaboration proved vital. Their initial funding came in August 2018 through a partnership with Kinisis Ventures, which valued Threedium at an estimated €1.5 million. Today, Threedium boasts a team of 58 professionals operating across three countries: the US, the UK and Cyprus. As of January 2024, Threedium successfully raised funding through a Series A offering in the US, achieving a post-money valuation of approximately $40 million.
Valuing innovation requires a blend of analytical rigor and storytelling prowess. As the landscape of technology continues to evolve, so too must our approaches to understanding the worth of groundbreaking ideas.
Valuing businesses with little or no reported revenue, negative cash flow or no profit presents a significant challenge, especially when their financial futures remain uncertain. Established public companies with consistent revenues and earnings can be effectively valued using market methods that rely on Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA) multiples. However, new ventures, which are often not publicly traded and may be years away from generating revenue and EBITDA, require different approaches.
When valuing a firm without revenue, extensive forecasts are required to project future sales or earnings once the product or service is commercialised. To derive these revenue
estimates, investors should consider the following four critical questions:
What is the market size for the product?
What competitive advantages does this company’s product have over those already generating revenue?
What are the costs associated with implementing and commercialising the product, including customer acquisition expenses?
How long will it take before competition intensifies in the market?
Ultimately, investors are more likely to provide capital when they are convinced by the venture’s narrative. While established corporations are typically valued based on current earnings, startups are often assessed based on projected future revenue multiples, reflecting the unique dynamics of their growth potential.
The valuation of most startups hinges on their future potential, making Discounted Cash Flow (DCF) analysis a critical tool in this process. This preferred method of DCF involves projecting the cash flows a company is expected to generate in the future and then discounting those cash flows back to their present value using a specified rate of return. Given the high risk of failure associated with startups, a higher discount rate is typically applied, reflecting the uncertainty in generating sustainable cash flows.
However, DCF analysis has its limitations, particularly when it comes to forecasting future market conditions and making reliable assumptions about long-term growth rates. As projections extend beyond a few years, they can often become speculative. Additionally, DCF valuations are highly sensitive to the discount rate employed, so caution is warranted when using this approach for startups.
An alternative approach to startup valuation is the development stage valuation method, commonly utilised by angel investors and venture capital firms. This method allows for a quick estimation of a company’s value based on its stage of commercial development. The “rule of thumb” values assigned by investors typically reflect the maturity of the venture: the more advanced the company is in its development, the lower the risk and the higher its valuation.
A typical valuation-by-stage model might look like this:
Estimated Company Value Stage of Development
€250,000 – €500,000 Has an exciting business idea or business plan
€500,000 – €1 million Has a strong management team in place to execute on the plan
€1 million – €2 million Has a final product or technology prototype
€2 million – €5 million Has strategic alliances or partners, or signs of a customer base
€5 million and up Has clear signs of revenue growth and obvious pathway to profitability
These value ranges can vary widely depending on the specific company and the investor’s perspective. Startups with only a business plan may receive the lowest valuations, while those that achieve significant development milestones can expect to see their valuations rise as investor confidence grows.
Many private equity firms adopt a milestone-based funding approach, releasing additional capital as the startup meets specific targets. For example, the initial funding round may focus on covering salaries for employees engaged in product development. Once the product demonstrates its viability, subsequent funding rounds can be allocated for mass production and marketing efforts.
Overall, understanding these valuation methods and their respective strengths and weaknesses is essential for both investors and entrepreneurs navigating the startup landscape.
Originally published in Cyprus Mail. To see original article click here.
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