Santa Cruz Tech Beat


What’s it worth?

By Mark Mitchell
Degenerate serial entrepreneur

May 26, 2016 — Santa Cruz, CA

How can we value a portfolio of illiquid start-ups?

Every year, Sand Hill Angels invests in number of start-ups. We know how much money we’ve invested (several million dollars a year) and what we’ve received in return (securities of various types). But, we have not, until now, tried to determine what those shares are worth.

One approach is to declare the problem vacuous. Our portfolio consists mostly of companies whose shares will be illiquid for a long time to come. So, whether the shares are (in some theoretical sense) worth one dollar or one million dollars, there is no way to exchange the shares for dollars. And companies that look great often fall apart, companies triumph after appearing all-but-dead, and markets shift quickly.

But, I believe it is important to value these companies precisely because they are so illiquid. Valuation, even if far-from-perfect, provides useful feedback to investors about their portfolios.

So, how can we value a portfolio of illiquid start-ups?

The first step is to eliminate most of the traditional methods of valuing companies. For example, the discounted cash flow method estimates value by looking at the cash flow likely to be generated by the company over the coming years and discounting for the interest rate you could obtain by investing in government bonds. That’s a reasonable approach for a large, slow-growing company that generates consistent returns — but completely impractical for a start-up that is expected to be unprofitable for years to come. Another method is to determine the enterprise value-to-revenue multiple for public companies in the same industry, and then apply that multiple to the revenue of the portfolio company. But, even assuming the start-up has revenue, it’s ludicrous to assign the same multiple that would be applied to companies millions of times larger. A third approach is to look at transactions (such as acquisitions or investments) involving comparable start-ups. But, it is difficult to find comparable companies — and even more difficult to obtain transaction data. Instead, we need a simple method that can be consistently applied across the portfolio.

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