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FOUNDING ANGELS
Valuation
Background
Especially for Founding Angels, valuating start-ups or start-up projects at very early stages is a challenge given the lack of historical data and many uncertain factors about the future. Therefore, we have developed a methodology for the valuation which has been proven in practice.
The risk linked to a start-up is expressed through an individual beta coefficient (Beta) as an important component of the discount factor (DF) within a discounted cash flow (DCF) calculation based on data taken from a business plan. The DF reflects the capital costs of the start-up and is the same as the required return on equity or the internal return on investment (IRR). Higher betas show higher risk and lead to an increasing DF.
Calculation
The exact formula to calculate the DF based on the risk free interest rate (RFR), the Beta and the market risk premium (MRP) is: DF = RFR + (Beta x MRP). In September 2020, the RFR in Germany was -0.52% and in Switzerland -0.49%. The MRP in Germany was 7.53% and in Switzerland 5.60%. Source of these values is the website "www.marktrisikoprämie.de".
Using the formula and taking a DF of 30% leads to a standard Beta for start-ups in Germany of 4.05 and in Switzerland of 5.45. These standard Betas can be adjusted individually for each start-up based on an assessment scheme taking operational aspects from the start-up into account.
For example, one aspect is financial resources. If they are secured for the next 2 years, there will be no adjustment of the Beta. If the financial resources for the next year are not secured, the Bata increases by 1. If the financial resources for the next 4 years are secured, the Beta will be reduced by 1. This assessment scheme enables a differentiated assessment and contains, in total, 20 assessment aspects within the five categories technology, products, implementation, organisation and finances (1).
A start-up in Germany with significant operational risk can have an individual Beta of 10 instead of the standard Beta of 4.05. The calculation with the above formula results in a DF of 75% instead of 30%. This DF can be directly used to recalculate the company value within the financial planning of the start-up and reflects the real risk and value of the start-up.
Application
The method is applicable to any early stage start-up with a first financial plan and especially facilitates a better comparison among start-ups resulting in a comprehensible comparison of different investment options for early stage investors. The following table shows such a comparison which was made in practice to find the best investment opportunities.
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