In Part 1, I outlined the three broad methods for valuing startups the Asset approach; an Income approach; and a Comparables approach and the challenges associated with trying to value startups in Sub-Saharan Africa and Uganda specifically. In this article, I shall share broadly how to apply these valuation techniques to a startup, using a technology startup as an example, and outlining some of the adjustments needed to reflect the unique characteristics of a startup. To recap, there are broadly
Asset approach: this would involve identifying what it would cost to recreate the startup today to deliver the product or service being provided including hardware requirements, developer time and inputs, payment for subscriptions and licences, filing for patents. Having determined these costs, which are the assets, any liabilities or debts owed would need to be deducted from the assets to arrive at a net asset value (NAV) and is usually thought of as a base or floor valuation. Needless to say this method does not take into account the potential cash flow that the venture would be able to generate.
Income approach: unlike the asset approach, the income approach takes into account potential income or cash flows. For a technology startup, for example that uses a subscription model or generates income from transactions, income expected per transaction or per subscriber would be projected into the future against growth in transactions or subscribers. From this is derived the net income or cash flow that would accrue to the startup after costs are deducted. This income or cash flow would need to be projected over say a 3 year period. Generally, projecting beyond 3–5 years may not be helpful as it is hard to project that far out for a startup business. At year 3, it may be assumed that investors in the company shall be able to sell the business for a given amount, usually a multiple of the money invested or a multiple of profit being generated or a multiple of sales, the multiple may vary for example one may seek say 3X — 5X cash invested depending on business risk. The net income or cash flows and the final sale value would need to be discounted to today’s value at a desired return for investors that reflects the startup company’s risk and the prevailing economic conditions, to arrive at a value today.
Comparables approach: There is a shortage of comparable transactions in the Ugandan startup market, a basis would be to look to similar startups or businesses in other jurisdictions for which transactions are available and note what value parameters (sales, profits, number of customers/users, number of downloads, customer lifetime value, etc.) and what multiples were applied to these parameters to arrive at a value. For example, Facebook paid $4 per user to arrive at $19 billion valuation for WhatsApp. However, increasingly with the African startup scene being covered and as deal information is disclosed, comparable transactions should start to appear. For example Digest Africa publishes at http://digestafrica.com/deals/
Adjustments: the valuation arrived at using any of the methods identified above would have to be adjusted upwards (premium) or downwards (discount) to reflect the issues and challenges identified above which can be linked to illiquidity (startups are difficult to sale), size (startups are small), lack of control (depending on the stake one owns) and intangible value (for example patents, brand). For each of these factors, the valuation identified would have to be adjusted. Typical adjustments may be for size (say 10% — 15% discount); for illiquidity (say 15% — 25% discount); for control (say 15% — 25% discount or premium depending on whether valuation is for a minority stake or majority stake respectively); for intangibles (this is very subjective and may be reflected in a premium or discount only implied in the purchase price paid).