Well it’s both and where it sits on the scale depends on the approach and the approach depends on the kind of company being valued….
DCF valuation….
This is the “science” part and in an ideal world how you would value all companies. The Discounted Cash Flow (DCF) method relies on forecasting the cash inflows and outflows over a period of time and then discounts these amounts over that period depending on how much more valuable $1 is today compared to in x years’ time.
The problem with this method is that “scientific” as it is its accuracy relies on how well these cashflows can be estimated. For an established company in a mature industry this is somewhat easier but for a lot of media and digital companies, particularly those at an early growth stage or innovating heavily these inputs can be hard to forecast accurately 12 months out let alone the 10-15 years that a traditional DCF valuation requires.
Revenue multiple…..
The methodology here is based on valuing a company by taking its revenue and applying a multiple based on what the market has paid for comparable businesses. In theory if you know that a company has recently raised financing based on a valuation of say 10x revenue. However there are a few obstacles. Firstly it can be very difficult to find comparable data in the market – actual valuation numbers are rarely disclosed publicly following funding rounds and the PE multiples of associated with publicly listed companies in the same industry can be extremely broad. Bill Gurley of Benchmark Capital wrote a great article “All Revenue is not created equal” analysing the inherent issues in simply applying an industry revenue multiple without properly analysing the underlying qualities of the revenue.
The Venture Capital Method….
This methodology effectively reverse engineers the valuation based on the required Return on Investment (ROI) for angel investors or VCs. If you know the ROI you want to make (say 15% to 20% – angel investing is a risky business) and you can estimate the value of the company when the investor exits in say 5 years’ time you can work out the valuation from there.
But whilst this method is useful if you’re the investor you may find that as a company this valuation this produces will be at the lower end.
It’s worth what the market will pay…..
Because a valuation is only one factor in getting a deal done. Five different valuation methods will produce at least five different valuations. There are other important factors to consider…
How many parties are interested in what you are selling? – the more investors that are interested the more negotiating power you have. After all how much more interesting does something look when you know others want it too….
How well do you tell your story? – how robust is your pitch and do you present your company and the opportunity in the best possible light. Does your presentation have all the information an investor needs to make a decision and more importantly to believe in your business…..
How easy are you to buy? – think carefully about who your likely investors are and make it easy for them. Make sure your corporate structure, financial records and legal documentation is tidied up. Yes it’s housekeeping and not razzle dazzle but by taking care of it upfront you’ll make the process much smoother and there’s value in that.
So it’s art, it’s science….and it helps to have a poker face….