Politics of Valuation 1 Presented by Steven R. Kopits March 2002

Politics of Valuation 2 Agenda Valuation Measures Calculating Your Worth

Politics of Valuation 3 Value Function for a Fund CASH OUT CASH IN TIME

Politics of Valuation 4 Two Valuations 1.Business Potential –Based on research and analysis 2.Share of the Company –Results of negotiation with entrepreneur

Politics of Valuation 5 Negotiating Space $ Company Value VC Maximum Value Entrepreneur Minimum Value Negotiating Space

Politics of Valuation 6 Valuation Techniques Price/Revenues Price/Earnings Price/EBITDA Price/Book Equity Price/Net Assets Price/Comparables DCF Price/Cash Price/SWEQ Price/SWILL Tradition Golden Handcuffs Turkish Bazaar

Politics of Valuation 7 Price/Earnings –Requires positive earnings –Easily distorted/manipulated –Ignores potentially important cash flow considerations Price/EBITDA –EBITDA: earnings before interest, taxes, depreciation and amortization –Measures of operating cash flow – which must be positive –Ignores Capex issues Valuation Measures

Politics of Valuation 8 Price/Assets –Assets-liabilities, all measured at market value –Requires assets: start-up may have expensed organization building >> little of no real assets Price/Book Value (Equity) –Requires history of profitability –Backwards looking –Easy to measure –Does not capture intangibles Valuation Measures

Politics of Valuation 9 Price/Cash Invested –Most conservative measure of resources actually invested in a project –Values benefit of labor at zero –Generally floor for discussions with VC Price/Cash Invested + Sweat Equity (‘SWEQ’) –Recognizes labor –Does not recognize upside potential of project –Lower limit of “tasteful” negotiation Valuation Measures

Politics of Valuation 10 Price/Cash Invested + Sweat Equity + Goodwill (‘SWILL’) –Recognizes cash, labor, and at least some upside potential –Goodwill may be tricky to measure Tradition –Established valuation range for company by stage, regardless of industry or specific merits of a given team or proposal –Durable measure, widely used Valuation Measures

Politics of Valuation 11 Discounted Cash Flow (DCF) –Most integrated and complete of all valuation measures –Highly sensitive to assumptions –Yields highest valuation Turkish Bazaar –Unconstrained negotiation –Indirect benefits may feature prominently Valuation Measures

Politics of Valuation 12 Golden Handcuffs –Minimum share given to entrepreneur to maintain his medium-term (3 year) commitment to the company –3-4 years salary equivalent –In line with “Traditional” method Valuation Measures VC’s should not enter a deal below the Golden Handcuffs threshold measure

Politics of Valuation 13 Measures by Stage

Politics of Valuation 14 Early Stage Valuation Biases FuturePresentHistorical $ High Med. Low Zero P/BV P/E Cash Inv. P/A SWEQ SWILL Tradition G. Handcuffs P/R Comp. DCF

Politics of Valuation 15 Early Stage Indicative Values

Politics of Valuation 16 Of 10 early stage investments – all with 7-10x cash-on-cash return requirements Developing IRR Hurdles Substantial project attrition and overhead costs reduce high expectations to modest returns EVCA average for early stage funds: 13-22% IRR

Politics of Valuation 17 What Are You Worth? VC Cash Leadership (CEO) Implementation (CMO, CTO, CFO) Idea Idea has limited value Ability to implement project is most important

Politics of Valuation 18 Entrepreneur must be aware of –Range of valuation measures which will be applied to the company –Which valuation measures are relevant –The negotiating implications of various measurement techniques Key Points

Politics of Valuation 19 Janos and Henry are both 27 years old and have founded a company in their spare time—each still has his full time job. They put $30,000 into the company, but far more in cash (to avoid taxes). They have also put in almost all their spare time for the last 18 months. Their company is now producing about $100,000 a year in revenues. They believe the company could grow rapidly with an injection of $1 million. How big does the company have to grow to attract venture capital investment? How much of the company will they own? What method will the venture capitalist use to knock-down the valuation? Case Study

Politics of Valuation 20 Contact Detail Steven Kopits, mobile: