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Valuation & Proposal

When you want to prepare an investment proposal you need to know the value or your business. You can use one of four valuation methods, but we will be using the Discounted cash flow method.

The present value of a business is basically determined by three aspects:
  1. the value of its assets minus its debts
  2. its ability to create a positive cash flow
  3. its future value against a discount rate
We discount future value according to the following principle:
  • when I offer you a debt certificate for 100 dollars that is payable in one day, you might be willing to pay me 99 dollars for it.
  • when I offer you a debt certificate for 100 dollars that is payable in one year, you might be willing to pay 90 dollars for it (I am good for it).
  • when I offer you a debt certificate for 100 dollars that is payable in one year and I tell you I need the money because I just lost my job, you might be willing to pay 70 dollars for it.
  • same situation as before, I am out of a job and I promise to pay you back in two years, how much would you pay me for my dept certificate of 100 dollars?
    • answer A: 70 dollars
    • answer b: 49 dollars
    • answer c: 40 dollars
The answer is ... because when you offer me 70 dollars for my debt certificate, the discount rate you offer me is 30%. The next year the discount rate is still 30%, but the debt certificate is only worth 70 dollars, so its is discounted by 30% of 70 dollars = 21 dollars. I.e. answer b is correct.

Investors see you as a person who needs the money because you just lost your job. Discount rates for start-ups vary from 30% to 80% depending on the strength of the business model and the experience of the entrepreneurs.

In the spreadsheet below you can enter your nett cash flows and the discount rate to calculate the present value of your business and the internal rate of return (ROI). The following should be taken into account:
  • make a copy of the spreadsheet for your own use
  • enter your entire investment budget in Year 0
  • you need to establish the end value of your business after year 7. We multiply the nett cash flow in year 7 with the "end value multiplier" (usually 5) and discount that value to the present.
  • Normally for start-ups the value of its assets minus its debts is zero
  • The present value of your company is under "present value"
When your present value is 500.000 dollar and an investor has invested 200.000 dollar they would be entitled to 40% of the shares in that company

See: https://sites.google.com/site/nilsdewitte/rbf-document-package

When you need to raise finance for your company, you don't want to give away most of your equity in the first round of finance. Usually investors provide the majority of the investment capital in the form of subordinated loans. These loans are subordinated because no collateral or guarantees are provided. When the cash flow allows, the loans can be repaid so the investor is less exposed. The share capital remains in the company until the shares are bought back by the entrepreneur(s) or the shares are sold to a third party.

When the company is very successful, the shares might increase in value twenty times over. This poses a serious problem for the entrepreneur(s). They don't have the money to pay for the shares so they need to sell their company to buy out the investors.

Investors prefer the Royalty Based Finance (or Revenue Based Finance) for cross border investments. The benefits are that investors share the risks of the investment wit the entrepreneur(s) and the entrepreneur(s) can buy back their shares for a fixed price.

The RBF package consists of three financial element with which can be played until a mutual beneficial financial package is constructed. The elements are:
  • A minority stake in the share capital (usually 30%)
    • not more than 10% of the investment amount is paid in share capital
    • the entrepreneurs have the right to buy back the shares for a fixed multiplier (usually 3x the amount that the shareholder paid for the shares)
  • A subordinated loan for the rest of the investment amount against a fair interest percentage (between 5 and 8 percent for hard currencies)
    • shares can only be bought back when loans are repaid and interests are paid.
  • A royalty fee on the revenues, either the projected revenues or the actual revenues whichever is highest
    • royalty payments stop when all loans and interest are paid and the shares are bought back from the investor
Details of the investment proposal can be entered in the spreadsheet below:

Kevin Ma,
4 Jul 2016, 17:58
Kevin Ma,
4 Jul 2016, 17:58