{"id":21720,"date":"2019-12-11T18:26:08","date_gmt":"2019-12-11T23:26:08","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/biws\/?post_type=biws_kb&#038;p=21720"},"modified":"2024-09-25T17:59:25","modified_gmt":"2024-09-25T22:59:25","slug":"startup-valuation","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/valuation\/startup-valuation\/","title":{"rendered":"Startup Valuation &#8211; How Are Startups Worth Billions? (14:10)"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Startup Valuation - How Are Startups Worth Billions?<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/startup-valuation\/#How_Are_Startups_Worth_Billions_of_Dollars\">How Are Startups Worth Billions of Dollars?<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/startup-valuation\/#A_DCF_for_Pied_Piper\">A DCF for Pied Piper<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/startup-valuation\/#Startup_Valuation_Myths\">Startup Valuation Myths<\/a><\/li><\/ul><\/nav><\/div>\n\n<style>.enteremail__large--inline{margin:60px auto!important}<\/style>\n<h2><span class=\"ez-toc-section\" id=\"How_Are_Startups_Worth_Billions_of_Dollars\"><\/span>How Are Startups Worth Billions of Dollars?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>\u201cI don\u2019t understand how tech startups can be worth billions of dollars \u2013 many of them aren\u2019t even making money yet!\u201d<\/p>\n<p>\u201cHow can an unprofitable company that isn\u2019t even generating revenue possibly be worth so much? Doesn\u2019t this violate all the principles of valuation?\u201d<\/p>\n<p>We get questions like the ones above all the time. The short answer is NO, startup valuation doesn\u2019t violate all the principles.<\/p>\n<p>You can still use standard methodologies such as the DCF, but you have to use radically different assumptions that make the analysis less grounded in reality.<\/p>\n<p>For the numbers to work, the startup has to start making A LOT of money very quickly in the NEAR FUTURE.<\/p>\n<p>If it takes 10-15 years to generate revenue, it will be almost impossible for the numbers to work; but if it happens in the next 2-3 years, it might be plausible.<\/p>\n<p>As an example, we look at Pied Piper in this lesson, the fictional company from the HBO show \u201cSilicon Valley.\u201d<\/p>\n<p>They make money with a file compression and storage app, and they\u2019re aiming to get hundreds of millions of users and then get a tiny percentage of them using their paid services.<\/p>\n<p>So if they currently generate no revenue and have just received $100 million in funding at a $1 billion valuation, is that crazy?<\/p>\n<div class='code-block code-block-2' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/04\/24164120\/adv-fm-tile.png\" alt=\"PowerPoint Pro\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Master Financial Modeling for Investment Banking With <strong>BIWS Core Financial Modeling<\/strong><\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Become a financial modeling pro<\/h4>\n              <p>158 videos, detailed written guides, Excel files, quizzes, and more<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Complete 10+ detailed global case studies<\/h4>\n            <p>These include both the theory and the practical applications<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Prepare for your internship or full-time job<\/h4>\n            <p>Gain the skills you need to \u201chit the ground running\u201d on Day 1\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/core-financial-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Core-Financial-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div><\/div>\n\n<h2><span class=\"ez-toc-section\" id=\"A_DCF_for_Pied_Piper\"><\/span>A DCF for Pied Piper<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>We assume massive app download growth in the early years, with the company reaching ~500 million annual downloads and ~150 million paid users by the end of Year 10. Revenue goes from 0 to nearly $2 billion over that time frame, which implies massive <a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/year-over-year-yoy\/\" target=\"_blank\" rel=\"noopener\">Year-Over-Year (YoY)<\/a> revenue growth rates.<\/p>\n<p>The company goes from negative Operating Income to nearly $500 million (25% margin) and almost $300 million in Free Cash Flow.<\/p>\n<p>We use a 100x EBITDA multiple to calculate the Terminal Value (arguably fair for a $2 billion company growing at nearly 40% per year).<\/p>\n<p>These assumptions are highly speculative, and so we also have to use a much higher Discount Rate: 50%, compared with the standard 8-12% figures you see for mature companies.<\/p>\n<p>As a result of all this, far more value comes from the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/present-value\/\" target=\"_blank\" rel=\"noopener\">Present Value<\/a> of the Terminal Value: 99% here, vs. 50-70% for normal companies (and ideally less than that!).<\/p>\n<p>The whole valuation is dependent on a huge number of assumptions that are impossible to know in advance: Will billions of people download the app? Will ~5% of users convert to paying customers? Will the company be able to monetize in only 2-3 years\u2019 time?<\/p>\n<p>These assumptions might turn out to be true, but there\u2019s a very high chance they might not be \u2013 which explains the 50% Discount Rate.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Startup_Valuation_Myths\"><\/span>Startup Valuation Myths<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>So the DCF does \u201cwork\u201d for startups; it\u2019s just not that useful because of all the required assumptions and the inability to guesstimate the numbers for a pre-revenue company.<\/p>\n<p>For a valuation to make sense, the company has to start generating money *very quickly* \u2013 if it takes ten years for that to happen, the numbers will be even harder to justify.<\/p>\n<p>And since the majority of the implied value comes from the Terminal Value, the Terminal Multiple and Terminal Growth Rate are incredibly important. They matter more than long-term profit margins because almost no value comes from the Present Value of Free Cash Flows.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>You\u2019ll learn about Startup Valuation in this lesson, and see how a traditional methodology such as the Discounted Cash Flow (DCF) analysis applies to early-stage tech startups with no revenue.<\/p>\n","protected":false},"featured_media":21909,"template":"","class_list":["post-21720","biws_kb","type-biws_kb","status-publish","has-post-thumbnail","hentry","kb_category-valuation"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/21720","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media\/21909"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=21720"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}