Section outline

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  • 1. Introduction

    Welcome to "Startup Valuation!" The valuation of startup firms is arguably the most fascinating but also the most daunting valuation task. This introductory section motivates the topic and provides an overview of the structure of the module. 


    startup course pic 


    The main learning goals of this module are:
    • Understand the many challenges we face when trying to value startups.
    • See how to adjust the DCF-approach in specific situations.
    • Learn how Venture Capitalists (VCs) value startups.
    • Understand the difference between valuations and issue prices.
    • Learn how to use real option considerations to value startups.
    Activities: 3
  • In this section, we discuss how to adjust the standard discounted cash flow (DCF) approach to get a rough assessment of the potential value of a startup firm.

    1. We start by revisiting the main elements of the DCF approach.
    2. Second, we discuss ways how to compile the financial plan to incorporate the vast uncertainty many startups face.
    3. Third, we look at how to estimate risk-adjusted discount rates for innovative firms.
    4. Fourth, we show how to adjust the DCF approach to handle the many additional risks that investments in startup companies bring about. In particular, we discuss the use of hurdle rates as well as the modelling of survival probabilities. We also briefly show how to handle cash flows with different risks in any given year.
    5. Fifth, we turn to continuing value and show how to roughly assess the long-term value of young firms. We present three popular approaches to estimate continuing value: Liquidation values, exit multiples, and a growing-perpetuity model.
    Activities: 3
  • In this section, we discuss how professional investors such as venture capitalists typically value (startup) companies. This so-called VC approach focuses on the potential value of the firm at a future point in time when the professional investors expect to exit from their investment (typically 5-7 years after the investment). It then compares the resulting valuation with the required capital to determine whether the venture promises to be a financially attractive investment or not.

    Activities: 3
  • So far, we have discussed ways to value startup companies despite the many additional sources of complexity and uncertainty these companies face. The next step is to investigate how we can get from the valuation to the actual issue price of the company's shares. That's the topic of this section.

    Activities: 3
  • Especially in the case of startups, managers still have a great deal of flexibility with respect to how implement the business idea. They can postpone some important business decisions and, in the meantime, learn about the market and the own comparative advantages. Management flexibility is often referred to as Real Options. In this section, we discuss the idea of real options and introduce three popular approaches to value these options: Decision trees, Binomial trees, and the Black-Scholes-Merton Model. The focus of this section is more on the technical aspects of option valuation. In the next section, we then discuss in some more detail how (and how not) to implement real options in the entrepreneurial setting.

    Activities: 4
  • In this concluding section, we take a closer look at how to identify real options and how to implement real option valuation. To understand whether a real option is "real" (valuable), three simple questions can help: Is there optionality? Is there exclusivity? Can we value the optionality? To implement the valuation models, we then need to estimate the relevant parameters. The section briefly discusses how we can get rough estimates of the key value drivers of options. Then we look at specific cases, including the options to delay, expand, and abandon. We conclude with some general remarks about the management implications or real options.

    Activities: 3