This segment of The Startup Club Valuation Series focuses on what early-stage tech companies should consider during the valuation process.
When valuing convertible bonds issued by early-stage Technological companies, a number of factors should be considered, including:
1. The change in market and sector pricing conditions.
Due to its innovative nature, the startup business environment can be unstable: new competitors can enter the market; the product can evolve; or the demand for the product or service can become obsolete. It's therefore important to constantly evaluate the market environment.
2. Funding risk, cash burn, and liquidity profile of the company.
About 90% of startups fail. 10% of startups fail within the first year. You cannot protect yourself fully from this risk, but you can do your research on the company to diminish the risk as much as possible.
3. The seniority of the bond in the capital structure of the company.
What other sources of funding does the company have?
4. Recent developments in the underlying technology and innovation of the business and the industry.
Is the startup still delivering on its promise? The industry can change rapidly and new technologies can emerge.
5. The probability of default, loss given default, and expected volatility in the listed share price of the company (or its closest comparable).
You need to evaluate in advance the potential loss you would infringe if the company goes down and be prepared to deal with the situation.
Due to the difficulty of gauging the probability and financial impact of the success or failure of development activities of early-stage companies, one should consider that the traditional valuation techniques cannot be used in all cases. It needs the use of more complex valuation methodologies, when necessary.
These may include:
1. Scenario-Based Model (or PWERM).
2. Option Pricing Models.
3. Milestone-Based Model (or adjusted price of recent investment).
4. Monte Carlo Simulation.
By Dulal Das
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