How to Value a Startup


By Neil Portus, CFA, CMA
Neil Portus is a freelance CFO & Advisor for growth companies at Tailored Partners and a former Vice President & Equity Analyst at Goldman Sachs in New York where he covered car rental and mobility stocks.
* Visit our store to download a free copy of this presentation on “How to Value a Startup.”
* This article is also published by Neil on Urban Mobility Daily.

This year’s Autonomy & Urban Mobility Summit and companion Funding the Movement program provided a strong focus on up-and-coming mobility startups with over 120 early-stage companies attending, pitching or exhibiting.

With this focus on emerging companies and disruptive technology, I was invited to speak at the conference on “How to Value a Startup” in order to walk mobility innovators, policy makers and industry experts through my four-question valuation framework for a startup: (1) What are comparable companies worth? (2) What is the investor’s target return? (3) How viable is the customer acquisition strategy? and (4) Are expectations set too high?

Below are key highlights from my talk but be sure to visit our store to download a free copy of the full 75-slide presentation. I wrote it with a lot of detail and examples so it could be a helpful resource to those unable to attend in-person.

Key Highlights – How to Value a Startup

In speaking on startup valuation, it’s helpful to lay a bit of groundwork. Valuing companies is not easy as information is limited and fragmented. This is why investors frequently employ The Mosaic Theory which is a research approach whereby one arrives at an asset value by piecing together bits of available information. My perspective is that, if done in isolation, two people can often come up with a different valuation for a company. For an investor who has an in-depth understanding of a specific industry or sector, this limited availability and fragmentation of information is often what can provide them the edge to garner an outsized return on investment.

Additionally, valuation is only one of the key investment factors considered by early-stage investors. In my view, the quantitative and qualitative factors at play include:

  • Quantitative:
    • Revenue growth;
    • Customer churn;
    • Barriers to entry;
    • Market size/potential; and
    • Valuation.
  • Qualitative:
    • Strength of the management team; and
    • Uniqueness/long-term sustainability of the business idea.

With that groundwork set, I value startups by answering four questions:

1) What are comparable companies worth?
2) What is the investor’s target return?
3) How viable is the customer acquisition strategy?
4) Are expectations set too high?

The first two questions are more quantitative while the second two questions are more qualitative.

(1) What are comparable companies worth?

In this first step, we want to determine what other investors have paid for comparable businesses. A comparable business (sometimes called a “comp” or “comps” when referring to the whole peer group) is one that shares the same or similar: (a) industry, sector or subsector; (b) geography; (c) business model and/or revenue model; and (d) growth rate. Here, you don’t have to tick every box but you want to tick a lot of them. The reason “comps” are important is that investors often give the “market” credit that it broadly knows what it’s doing. So, the starting point for an investor is often what another investor has recently paid for something similar.

Selecting the peer group of comparable companies is the critical step. I generally see three paths based on the amount of information available:

  • Path 1: There are publicly traded comparable companies where a good amount of information is available; in the presentation, I walk through an example for luxury carmaker Aston Martin.
  • Path 2: There is a limited amount of information available for private comparable companies available through news reports and press releases; in the presentation, I walk through an example for Lyft and Uber.
  • Path 3: There is almost no information available from private comparable companies; in the presentation, I walk through an example for peer-to-peer car sharing startups comparable to Turo or Getaround.

For startups, investors will primarily focus on revenue growth as they want to know how big can this startup get. As a result, investors will generally value startups using a revenue multiple. As companies mature, investors will increasingly focus on profit growth. Here, investors start to look at multiples of cash flow or net income/earnings per share.

In my work with startup founders, I’ve found that one of the more helpful takeaways for them is that they can have an active voice in which companies comprise their peer group. Perhaps they are in an emerging sector with few existing, comparable companies or perhaps they believe their company has a disruptive technological or delivery angle which warrants a premium to other companies in the marketplace. Founders can influence valuation by identifying and supporting a peer set of comparable companies with more attractive valuations.

Once investors derive a revenue multiple from a peer group of comparable companies, they may adjust it higher or lower based on several factors. Potential discounts include if the startup is growing at a slower rate than peers as well as for a lack of liquidity if a set of public comparable companies is used to value a private company. Potential premiums include if the startup is growing faster, it may warrant a higher multiple than peers.

(2) What is the investor’s target return?

Given the risk profile of early-stage companies, investors frequently come to the table with a high bar for their target return. The question is, if private equity investors (who invest in more mature, private companies) often target a 3X return, how does an early stage investor achieve a similar return if +50% of startups fail?

Since a lot of startups fail, investors need the ones that succeed to do really well. So, for example, an early stage investor who targets a 10X return on each investment will achieve a 5X return on their portfolio if half of the companies fail.

An investor will receive an increased ownership stake in the startup for the same dollars invested as the valuation decreases. The net result is that an investor’s higher target return (i.e. 10X) can put a cap on the round’s valuation multiple.

In the presentation, I walk through a detailed example as to how an investor would calculate a 10X return and how this might result in a cap on the valuation multiple.

(3) How viable is the customer acquisition strategy?

This begins the more qualitative third and fourth questions in my framework.

Here, I seek to understand what can the startup provide to support its growth profile because, without meaningful support, I believe investors will be skeptical. A couple of key questions I ask include:

  • Is someone on the team experienced in leading customer acquisition?
  • Do they have a measurable and thought-out process – i.e. a multi-step process to identify leads, qualify them and then turn them into potential opportunities and, finally, customers?

Next, I want to be sure the economics make sense by exploring key questions such as:

  • What will they spend to acquire each new customer?
  • How valuable is each new customer they are acquiring?
  • What supporting data do they have?

I find that it’s hard not to land at looking for some type of Customer Lifetime Value (LTV) to Customer Acquisition Cost (CAC) analysis. While a LTV to CAC analysis is often used for a unit economic analysis for Software-as-a-Service (SaaS) businesses, I’ve seen it effectively applied across many industries. In the presentation, I walk through a high-level LTV to CAC example.

(4) Are expectations set too high?

With this fourth question, I try to gain a sense of whether I think the startup will beat or miss the operational milestones they are laying out in their investor deck, including:

  • Revenue targets and/or sales goals;
  • Number of users;
  • Number of cities they enter;
  • Number partnerships they develop;
  • When they turn profitable; and
  • Number of employees they can hire to scale.

Key questions I will ask include:

  • Can this team execute?
  • What about the team’s history of delivering on expectations?
  • Do they have a track record – i.e., are they second or third time founders?

Expectations are important because, simply put, if you miss them, investors will lose confidence. Conversely, if you beat expectations, investors will gain confidence. There is reputation risk if a startup misses expectations materially or repeatedly in that the next investment round may be a down round at a lower valuation or the startup won’t be able to raise funding at all.

It’s a startup founder’s role to “manage expectations” and walk the tightrope of being aspirational with the company’s vision and goals while not setting them too high that they routinely miss them.

Conclusion: How do we apply all of this?

For a startup founder, I find that the “comp set” derived through question #1 often reflects their ideal valuation multiple while, for an investor, their target return derived in question #2 can cap the valuation at a lower multiple. In this scenario, my view is that the founder’s multiple can be the ceiling while the investor’s multiple can be the floor for the valuation conversation. Then, the more compelling the answers are to question #3 (How viable is the customer acquisition strategy?) and question #4 (Are expectations set too high?), the more likely investor demand will rise lifting the round’s valuation multiple towards the ceiling. Without compelling answers, valuation will be pressured down or the round won’t get done at all.

Copyright 2018 Tailored Partners LLC

Is e-scooter startup Bird worth $2 billion? Yes but only if it can do something most other B2C mobility companies cannot


By Neil Portus, CFA, CMA
Neil Portus is a freelance CFO & Advisor for growth companies at Tailored Partners and a former Vice President & Equity Analyst at Goldman Sachs in New York where he covered car rental and mobility stocks.
* Visit our store to download a free copy of this Excel financial model for an e-scooter startup.
* This article is also published by Neil on Urban Mobility Daily.

No doubt you have read recent news reports that e-scooter startup, Bird, raised $200 million from investors in June at a valuation close to $2 billion, only one month after it raised $100 million at a valuation close to $1 billion and three months after it raised $100 million at a valuation close to $300 million. Naturally, many people are wondering, “how is Bird already worth $2 billion??”

Chart 1: Bird’s Valuation Since March 2018

I had the same question too. So, I delved into the numbers and, to my surprise, realized that I was indeed able to reach a $2 billion valuation. I even built my own three statement financial model for a hypothetical e-scooter startup.

However, to reach $2 billion, I had to make one critical assumption which contradicts both my experience as a consumer of mobility services and my time as a Wall Street equity analyst covering car rental and mobility stocks. It’s something which I think is the Achilles heel of most B2C (business-to-consumer) mobility services such as ride hailing, car sharing, car rental, peer-to-peer car sharing, carpooling and bike sharing:

They have no pricing power.

Put another way, my perspective is that most B2C mobility services have no consistent ability to raise prices while simultaneously growing their market share. Pricing power is one way a company’s customers can demonstrate their brand loyalty. However, I believe that consumers view many of these mobility services as commodities with no material difference in the service or product offering from one company to the next. As a result, I often observe that a primary avenue for a competitor to capture market share is to step-in and undercut on price. With customers ready to jump ship as soon as a cheaper, viable alternative emerges. Further compounding the problem can be sector dynamics which lead to supply exceeding demand thereby putting additional pressure on pricing. During my work as an equity analyst, I observed US car rental companies over-suppyling the market for a variety of reasons: a pursuit of market share at the expense of profits; holding on to older cars longer so they don’t have to sell them during a period of declining used car values; and free cancelations and fluctuating seasonal demand which made it difficult to optimize fleets.

I’m sure you’ve heard of the adage “Better, Cheaper, Faster” with the tagline that, as a consumer, you can have two but not all three. However, as a mobility consumer, I consistently want to get places better, cheaper and faster:

* I find myself often booking the airline offering the lowest fare. Years ago, I would spend over $1,000 in the summer to fly round trip from New York City to Europe while, this year, I spent approximately $750 on new low-cost, long-haul airline Norwegian Air;
* For years, I booked rental cars on Priceline in search of the lowest bidder; and
* Several years ago, like many New Yorkers, I swapped the city’s yellow cabs for an Uber and, more recently, Lyft — as new mobile technology provided a cheaper, more convenient alternative.

One arena where I have observed pricing power is with monopolistic mobility services like New York City’s CitiBike. They are better positioned to raise prices and increase market share. Notably, annual CitiBike memberships have risen in cost to $169 currently from $95 in 2014 when the service launched.

With all of this in mind, I set out to build a financial model to see if I could:

(1) Value a hypothetical e-scooter startup at $2 billion; and
(2) Show what impact a lack of pricing power could have on that valuation.

First, I essentially backed into a $2 billion valuation and, while lofty, discovered that the assumptions are not unbelievable when broadly compared to Uber. In year one of my hypothetical e-scooter startup, I assume the business has a healthy start and adds 500,000 new recurring users resulting in an average of 250,000 users for the year who take three rides per month at an average total price of $2.50 per ride. This yields $22.5 million in annual revenue (250,000 average users x 3 rides per month x 12 months x $2.50 total price). Bird’s pricing is $1.00 (fixed) plus $0.15 per minute (variable) which I mirror and assume each ride is 10.0 minutes to reach a total price per ride of $2.50 in the first year. Next, if net revenues have an average net growth rate of 105% for the next 5 years, the company will generate $815 million in revenues at the end of its sixth year ($22.5 million x 2.05^5). At a 6 times revenue multiple, the business will have an enterprise value of $4.9 billion which, if discounted back five years at 20% and assuming the company has no debt, yields a present equity value of $2.0 billion ($4.9 billion / 1.20^5). This illustration is more simplified than my model but shows the growth needed.

Chart 2: Reaching a $2 billion valuation for my hypothetical e-scooter startup

Testing two additional scenarios: Because there is limited data on the number of recurring users (i.e., someone who routinely uses the service, say, 3 times per month as I’ve assumed above) Bird has added during its first year of operations, I tested two additional scenarios noting that Google Play shows over 500,000 Android downloads and the Apple App Store shows over 185,000 iPhone reviews for Bird’s app (not everyone leaves a review so this indicates a higher number of downloads). However, just because someone downloads the app does not mean they are routinely using the service. That said, if my hypothetical e-scooter startup ends its first year with 1.0 million or 1.5 million new users (versus the 500,000 assumed above) who use the service 3 times per month at a total price of $2.50 per ride, then the annual net revenue growth rates needed to reach a $2 billion valuation using a 6 times revenue multiple are approximately 80% and 65% respectively.

These assumptions are lofty but investors are making a big bet. For an early mover in a disruptive service and a group of investors looking to get in on the ground floor, they are not unbelievable to me. I compare them to news reports that Uber raised $258 million in August 2013 at $3.7 billion valuation about five years after it was founded. This followed Uber achieving year over year net revenue growth of over 800% in both the first and second quarters of 2013 right before the raise. While I don’t know Uber’s forecasted forward net revenue number at the time of the raise, this valuation was 7.5 times Uber’s 2014 actual net revenue of $495 million.

Second, though I fully anticipate that the lion’s share of revenue growth will come from adding new users rather than price increases, I wanted to show what impact a lack of pricing power could have on valuation (i.e., if the price per ride is lower than expected). As illustrated above, revenues in my model are driven by three metrics: (1) number of users; (2) number of rides per user per month; and (3) total price per ride (which is a function of rate x time). In my model which scaled to a $2 billion valuation based on 500,000 new users added in year one, one of my assumptions was that the fixed and variable rates would grow 10% annually from year one’s pricing of $1.00 per ride (fixed) plus $0.15 per minute (variable). By keeping the length per ride constant at 10.0 minutes, this meant the total price per ride grew from $2.50 in year one to $4.03 in year six. So, I held all assumptions constant (including the length per ride) and tested the impact on valuation of a reduced growth rate in the price per ride. I found that, for every 1% annual change in growth rate for the fixed and variable price rates, valuation increased or decreased by roughly $90 million (the impact per percentage point decreases as rates are lowered and increases as they rise). So, if the fixed and variable rates grew at 5% annually rather than 10% as initially modeled, this 5% decrease knocked off approximately $420 million (or approximately 21%) from valuation in my hypothetical e-scooter startup model. If you want to test your own assumptions and draw your own conclusions on pricing power, please visit our store to download a free copy of the model.

Chart 3: The impact on valuation from lower than expected price per ride

So, while I now better understand the bet Bird’s investors are making, I think the fly in the ointment for B2C mobility investors remains. If Bird can navigate early structural headwinds (i.e., scooters are illegal in some cities while others are impounding them or capping their numbers) and execute well, its success will attract even more competition whose primary path to build market share will be to deliver a similar experience while undercutting on price — with consumers ready to switch brands to take up this new offer. With news reports indicating that competitor Lime recently completed its own big raise of $250 million at a valuation close to $1 billion, able competition is already present.

I see this as a sector where few companies demonstrate long-term pricing power, and missing the mark by even a few percentage points will sour the investment case for most investors.

Copyright 2018 Tailored Partners LLC