Understanding Key Drivers of Early Stage Valuations

1. ‘Meet the Valuation’
Understanding Key Drivers of Early Stage
Valuations
Raghav Bahl
www.thenetwortheffect.com

2. ‘Meet the Valuation!’ – understanding key drivers of early
stage venture valuations
 Why is it so difficult to agree on an early stage valuation metric?
 What are the Key Drivers of an ‘Early Stage’ Valuation number
 What Happens in a Bubble market
 Risks of Over and Under Valuation
 Summary
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3. From ‘Valuation’ to ‘Early Stage Venture Valuation’ –
number of results on Google went to 1/4th !
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Search: ‘What is
Valuation’
Search: ‘Early Stage
Venture Valuation’
110 Mn 28 Mn
‘Scholarly’ + ‘Art’ + ‘ Professional Valuer’ = FRICTION

4. What is an Early Stage Venture Valuation? - ‘Handshake’ of
founder expectations and investor return potential!
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Expectations can be WILD !
Not Enough Data
Poor Understanding of Key Valuation Drivers
Little understanding of risks related to
Over and Under Valuation

5. Understanding Key Drivers of Valuation Metric
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VALUATION
COMPANY
PERFORMANCE
METRIC
VALUATION MULTIPLE
Revenue Price / Revenue
Contribution Margin Price / Contribution
EBITDA EV / EBITDA
USERS ! Price / User !
EyeBalls !! Price / EyeBall !!
GMV (or GBV) Price / GMV
Earnings Price / Earnings
TRIED &
TESTED
More CREATIVE!
Or
Special Situation
Metrics

6. Performance Metric – Recognizing the Uncertainties
5
Spend per user
per year
Users
Market Size
Market Share (%)
Revenue Variable Cost
Marketing
Spend
Contribution
Margin
CAC
New Customers
Acquired
Contribution
Post Marketing
Salary &
Overheads
EBITDA
WC & Capex
Cash Burn
KEY
UNCERTAINTY NODE
CALCULATION NODE
Fixed
Variable Cost
Variable Cost

7. Where there is a will, there is data!
 There is always some data –
 Customer’s willingness to pay – ‘Rs / Km for taxi service’
 Frequency of transactions – ‘2 times a month for grocery’
 Cost of servicing the customer – ‘van rent, Km run, orders per day’
 Engineering team cost – ‘market salary’
 Early experiments with online marketing
 Other Startups
 Their experience with marketing, ops, customer behavior
 Venture Capitalists !
 If they can’t help you with this data – they don’t understand the
business – please avoid taking capital from them
 “Imagine marrying the wrong girl”
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Building data around uncertainties while avoiding ‘garbage-in is garbage out’
situation drives higher confidence in business plan

8. Valuation Multiple – Sustainable growth, higher capital
efficiency and lower risk drive high valuation multiples
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VALUATION
MULTIPLE
SUSTAINABLE
GROWTH
CAPITAL
EFFICIENCY
RISK
Large Market Size
Strong Value
Proposition & Product
Marketing
Spend
Cash Burn
Competition
Economics at Scale
Can this Team
execute?
Consumer
Behaviour Change
How much more
money will this need?
KEY
UNCERTAINTY NODE

9. Sustainable growth & capital efficiency together explain
public market valuation multiples better
8
-
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
10.00
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0%
-
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
10.00
- 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00
-
0.50
1.00
1.50
2.00
2.50
- 2.00 4.00 6.00 8.00 10.00
EV / Sales Vs 1 Yr Forward
Sales Growth
EV / Sales Vs 1 Yr
Gross Margin / Marketing spend
EV / Sales Vs 1 Yr
Product of Marketing Efficiency & Sales Growth
FB
BABA
GRPN
GOOG

10. The ‘Growth – Burn’ Triangle
9
Marketing spend
New Revenue
Total Revenue
Return on Marketing
INPUT / OUTPUT
VARIABLES
Revenue Retention
Marketing Efficiency
Contribution Margin

11. The Model Construct
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New Revenue
Marketing
Spend - 1
Marketing
Efficiency - 1
Revenue
Retention
Month 1 Retained New
Revenue
Month 2
New Revenue
Marketing
Spend - 2
Marketing
Efficiency - 2
$100
$50
$100 $150
$20 5 $20 5
Cash: 15-20 = -5
Growth: 50%
Retention: 50%
Month 1 Month 2
Contribution: 10%
BASE CASE
Growth (%) 50%
Cash Burn -5

12. The Model Construct – Change in Contribution Margin (CM)
11
New Revenue
Marketing
Spend - 1
Marketing
Efficiency - 1
Revenue
Retention
Month 1 Retained New
Revenue
Month 2
New Revenue
Marketing
Spend - 2
Marketing
Efficiency - 2
$100
$50
$100 $150
$20 5 20 5
Cash: 12-20 = -8
Growth: 50%
Retention: 50%
Month 1 Month 2
Contribution: 8%
BASE CASE 20% CHANGE IN
CM
Growth
(%)
50% 50%
Cash
Burn
-5 -8

13. The Model Construct – Change in Revenue Retention (RR)
12
New Revenue
Marketing
Spend - 1
Marketing
Efficiency - 1
Revenue
Retention
Month 1 Retained New
Revenue
Month 2
New Revenue
Marketing
Spend - 2
Marketing
Efficiency - 2
$100
$40
$100 $140
$20 5 20 5
Cash: 14-20 = -6
Growth: 40%
Retention: 40%
Month 1 Month 2
Contribution: 10%
BASE CASE 20% CHANGE IN
RR
Growth
(%)
50% 40%
Cash
Burn
-5 -6

14. The Model Construct – Change in Marketing Efficiency (ME)
13
New Revenue
Marketing
Spend - 1
Marketing
Efficiency - 1
Revenue
Retention
Month 1 Retained New
Revenue
Month 2
New Revenue
Marketing
Spend - 2
Marketing
Efficiency - 2
$100
$50
80 $130
$20 5 20 4
Cash: 13-20 = -7
Growth: 30%
Month 1 Month 2
Contribution: 10%
BASE CASE 20% CHANGE IN
ME
Growth
(%)
50% 30%
Cash
Burn
-5 -7

15. Marketing Efficiency is the single biggest driver of
GROWTH & CASH BURN
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BASE CASE
Growth (%) 50%
Cash Burn -5
BASE CASE 20% Change in
Contribution Margin
Growth (%) 50% 50%
Cash Burn -5 -8
BASE CASE 20% Change in Revenue
Retention
Growth (%) 50% 40%
Cash Burn -5 -6
BASE CASE 20% Change in Marketing
Efficiency
Growth (%) 50% 30%
Cash Burn -5 -7

16. Develop better understanding of early stage risks
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RISK
Competition
Economics at Scale
Can this Team
execute?
Consumer
Behaviour Change
How much more
money will this need?
“Winner Takes All
Vs 1% of $ 100 Bn”
What have you done really
well up till now – product, team etc
View on target segment behavior
over a timeline
EBITDA 5-7 year out
Capital Efficiency
THINGS TO PREPARE FOR

17. Performance Metrics – What happens in a Bubble !
16
Spend per user
per year
Users
Market Size
Market Share (%)
Revenue Variable Cost
Marketing
Spend
Contribution
Margin
CAC
New Customers
Acquired
Contribution
Post Marketing
Salary &
Overheads
EBITDA
WC & Capex
Cash Burn
KEY
UNCERTAINTY NODE
CALCULATION NODE
Fixed
Variable Cost
Variable Cost

18. Valuation Metrics – What happens in a Bubble
17
VALUATION
MULTIPLE
SUSTAINABLE
GROWTH
CAPITAL
EFFICIENCY
RISK
Large Market Size
Strong Value
Proposition & Product
Marketing
Spend
Cash Burn
Competition
Economics at Scale
Can this Team
execute?
Consumer
Behaviour Change
How much more
money will this need?
KEY
UNCERTAINTY NODE

19. Risks of Crazily Over and Under Valuation
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Crazily Over
Valued
Crazily Under
Valued
Raising Next Round
can be a pain
Explaining this to your TEAM –
value of ESOPs
Pain for Existing Investors
Spending time in preserving
valuation rather than improving
business metrics
Media Frenzy
Motivation for the Entrepreneur!
What do existing investors know
that new ones don’t?

20. In Summary
 Sustainable Growth, Capital Efficiency & Competitive intensity are core drivers
of valuation in the short and long run
 Marketing efficiency is the single biggest driver of GROWTH and CASH BURN in
the early stages of venture development
 If you have solved for Marketing Efficiency and one of either Contribution Margin
and Repeat behavior – Please call Me!
 Identify ‘Key Uncertainties’ in the business and work with Investors towards
building estimates based on prior experience or early experiments
 Over Valuation - valuation reverts to fundamentals quite dramatically – raising next
round of funding, value of ESOPs, dilution pressure for existing investors are a lot of
pain than the ‘on paper’ valuation prize in the short run
 Under Valuation – too much dilution for the founders upfront is a big risk
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