2023-11-24 04:43:18
The recent stock market crash of the company WeWork, the unicorn that was worth $47 billion, once again calls into question the valuations of start-ups. These are characterized by basing their business on an innovative idea, having a rapid growth objective, and, ultimately, by their high risk. In financing rounds, essential for their development, financiers, investors and advisors face the challenge of attributing market value to emerging businesses, with no financial history (because they usually have not started to generate profits or even income), and in a market with high volatility.
Valuation challenges
The first question when trying to value a start-up is what stage of the maturation cycle it is in, because the risk factors to which it is exposed and its level of exposure will vary significantly depending on whether it is in the development phase. the business idea, launch, growth or maturity.
Regarding the starting information, in the best of cases there will be a business plan that estimates future cash flows, which are very uncertain, given the innovative nature of the company. Furthermore, normally the business plan will reflect a more or successful survival and development scenario, which is not the most likely given that half of start-ups do not survive beyond five years.
To take this uncertainty into account, many investors simply apply very high discount rates (20%/40%) in their discounted cash flow valuation. However, from a technical point of view, this approach has limitations, because it combines external market risk with the inherent risk of the business within the same rate, without a clear distinction or specific measure of the implicit risk of these businesses.
An alternative approach
At Accuracy we believe that the key lies in estimating the probability of survival of the start-up in the long term, taking into account how both external (eg regulation or technological) and internal (eg governance or logistics) risks that loom over the business will be affected. business. To do this, in a first step, we classify the start-up under evaluation based on its risk, by comparing it with a reference base case.
Once classified, we use historical databases that allow us to establish relationships between certain parameters of the business model with the risk of entering into a situation of insolvency and dissolution, to estimate the probability of survival of the company in the medium term. Once this probability is found, we apply it to the valuation of the start-up obtained through conventional methods, avoiding the inconveniences of weighing the specific risks of an incipient and novel business in the discount rate.
This approach has the advantage of focusing on the concept of “probability of success”, which is familiar and understandable to both financiers and non-financiers (unlike the discount rate). Likewise, it incorporates objective criteria and discriminates between degrees of maturity, allowing investors understand the factors that impact value.
* Eduard Saura is a partner and Chloé Pehuet is manager of Accuracy
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