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Valuation

Valuing early-stage companies can be more of an art than a science. Here I'll explain the basics behind discounted cash flow (DCF) and multiple-based valuation, and detail how they are implemented in Foresight's models.

Valuation is tricky. Valuing a company take a combination of art and science: the math isn't hard, but applying the math correctly takes some experience to understand the real-life, practical thinking and context behind the math. It's easy to put the calculations to create a discounted cash flow valuation (DCF) in a spreadsheet, but much harder to make sense of it and apply it to real-life situations.

That's why I've always resisted putting company valuations into the model templates, but after feedback from users I reconsidered and decided to build a structure for valuation into the model. The Forecast sheet in the Standard Model will do a discounted cash flow and EBITDA multiple valuation based on the projections in the model. Just be careful in using it; don't forget the art to valuation behind the math.

There are a few methods commonly used to value companies:

Discounted Cash Flow

Discounted cash flow, or DCF, is a common method that values a business based on its future cash flows. The method is straightforward to do: create a forecast of the company's future free cash flows (forecast net income, then adjust for non-cash expenses from the income statement and capital expenditures and working capital requirements), then discount the future free cash flow to their present value, generally using weighted average cost of capital (WACC) as the discount rate (see links below for resources for identifying the right WACC for your business). The valuation of the equity of the business is the sum of the present value of the future cash flows, and then you can adjust for cash and debt to determine the enterprise value of the firm.

For mature businesses with stable, predictable cash flows, the DCF method is a classic, valuable valuation technique. But for startups with highly variable cash flows and immature business models, and perhaps zero revenue history, using a DCF is challenging at best.

Here is a primer on DCF valuations and a good explanation of the discounted cash flow method.

Multiple-based valuation methods

Another way to value a business is to compare it to other sales of other, comparable businesses, typically calculating the multiple of revenue or earnings (usually EBITDA or some operating income metric) that the other business sold for. For example, if a company was sold for $50mm, and prior to the transaction it had trailing twelve months revenues of $10mm, then it was valued at 5x trailing 12 revenues.

Multiple-based valuation methods rest upon finding comparable companies and transactions, which can be challenging to do, and often relies upon finding multiple companies that could be roughly comparable and estimating the multiples they sold at, using whatever information you have. With public companies, there is a lot of data to use, but with private companies it can often be difficult to find good data. The other important thing to note is that the method still relies on a lot of interpretation in the comparables, as comparing the margins, past growth rates, sustainabiity of the business models, and growth potential between companies can take a lot of analysis and judgement.

Here is a primer on multiples-based valuations

Many valuation firms will use multiple valuation methods, including qualitative scorecard-based methods or industry-specific techniques, and then decide on how to weight them to calculate range-based, weighted-average valuations. Here's a good overview on more valuation methods and how they are typically used in different situations ›

FE International has a great overview of valuation techniques and nuances in valuing an online business at How to Value a Website or Internet Business in 2023.

VC Method

One method that can be helpful for early-stage companies is the VC Method, which is based on the concept of estimating the future exit potential of the business, how long it would take to exit, how much funding it would require, and calculate the valuation today in order for the investor to achieve a specified rate of return, given the amount they are investing in the company. Straightforward to implement, although it requires a lot of assumptions about the business to use effectively. Here are a number of spreadsheet tools for using the VC Method.

If you are doing a valuation to justify a fundraising round, always remember that the amount of money raised in a round divided by the target percentage of the company sold in the round equals the postmoney valuation, and often the round and ownership sold can be compared to other similar funding rounds.

Another method that investors and founders can use for valuing an investment round is to forecast the future funding rounds of a company, create an exit waterfall to determine the proceeds at a range of different exit values, and then assume the probability of each of those exit values, to create an risk-weighted average return on investment. For one way to do that, check out and download Foresight's Venture Valuation Tool.

How to use

Please tred carefully into using the Valuation forecast. Valuations are highly dependent on the industry-specific assumptions and the variability of the underlying cash flows, and using these methods could help, hurt, or distract you from the meaningful components of a valuation conversation.

Often when sharing the model with investors I advise entrepreneurs to remove the valuation-related calculations from the Forecast sheet, just to focus the discussion on the business, not the exits.

How it works

From the assumptions on Get Started, the valuation-related calcs on the Forecast sheet then calculates the valuation of the company at each point in time, meaning the valuation at the end of every month, quarter, or year, based on what has happened so far and what it expects in the future.

Inputs

The Valuation assumptions are on the Get Started sheet, and consist of:

Discounted Cash Flow (DCF) Method

  • WACC (used as NPV Discount Rate - WACC = Weighted Average Cost of Capital. Good data source for industry-specific WACC ›
  • WACC (NPV Discount Rate, quarterly) - converted to a quarterly rate for NPV calculations
  • WACC (NPV Discount Rate, monthly) - converted to a monthly rate for NPV calculations

Terminal Value Calculation (for DCF)

  • Discount Rate (WACC)
  • Long-Term Growth Rate - Choose long-term growth rate applicable for your company or your industry. Good dataset here ›

Multiple Valuation Methods

  • Valuation Multiple: X multiple of Revenue - Multiple of trailing 12 months net revenues. Industry-based comparable multiples require research and analyis for your industry. Questions, contact me.
  • Valuation Multiple: X multiple of EBITDA - Multiple of trailing 12 months EBITDA (earnings before interest, taxes, depreciation, and amortization). Industry-based comparable multiples require research and analyis for your industry. Questions, contact me.

Common Modifications

These calculations are not commonly modified, but can be changed or added to based on the valuation analysis best for the specific situation.

Using Equidam for Valuations

If you decide you want a third-party valuation to assist in your valuation discussions, Equidam is very straightforwrd to use. Simply signup, fill out their questionnaire about your business, and input your financial projections (which can be generated from any Foresight financial model), and Equidam creates a valuation analysis through a weighted-average of five different valuation methodologies. Once your valuation is complete, you can update your answers and projections and access your valuation for the period of time that you select. [1]


  1. Links to Equidam are referral links for which Foresight receives a percentage referral fee. ↩︎