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Chapter 9 VALUING EARLY-STAGE VENTURES FOCUS In this chapter, we introduce basic concepts of valuation, the process of estimating values. We consider the owner of a growing business who is beginning negotiations with a potential investor. We introduce the mechanics of valuation and some mathematical simplification that can be used to value the venture. By dividing the venture’s future into an explicitly forecast period and a subsequent constant growth period, we can greatly simplify the valuation problem faced by the venture’s entrepreneur. We discuss two valuation methods that differ in how projected financial statements are created and when credit for creating surplus cash is granted. LEARNING OBJECTIVES 1. Explain how the time pattern of cash flows relates to venture value 2. Describe how valuation incorporates projections of near- and long-term success 3. Extract the necessary valuation data from projected financial statements 4. Understand the relationship between dividends and equity valuation cash flow 5. Put the pieces together for a unified treatment of financial projections and valuation CHAPTER OUTLINE 9.1 WHAT IS A VENTURE WORTH? A. Does the Past Matter? B. Questions C. Looking to the Future D. Vested Interests In Value: Investor And Entrepreneur 9.2 BASIC MECHANICS OF VALUATION: MIXING VISION AND REALITY A. Present Value Concept B. If You’re Not Using Estimates, You’re Not Doing a Valuation C. Divide and Conquer with Discounted Cash Flow 9.3 REQUIRED VERSUS SURPLUS CASH 9.4 EQUITY VALUATION: THE MAXIMUM DIVIDEND METHOD A. What’s Behind Our MDM Projections 9.5 ACCOUNTING VERSUS EQUITY VALUATION CASH FLOW A. Origins of Accounting Cash Flows B. From Accounting to Equity Valuation Cash Flows 9.6 EQUITY VALUATION: THE PSEUDO DIVIDEND METHOD SUMMARY LEARNING SUPPLEMENT 9A: VALUE MAXIMIZATION AND THE FIRST ENTREPRENEURIAL TEAM LEARNING SUPPLEMENT 9B: DISCOUNTING GROWING PERPETUITIES 143
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Chapter 9: Valuing Early-Stage Ventures DISCUSSION QUESTIONS AND ANSWERS 1. What is a venture’s present value? Does the past matter? A venture’s present value is the value today of all future cash flows discounted to the present at the rate of return required by investors. The value of the venture is not directly related to the quantity of past efforts in cash or sweat. While accounting for the past is all well and good, an investor seeks to quantify and value the future. 2. Describe what is meant by the statement “If you’re not using estimates, it’s not a valuation.” It is important to recognize that projected financial statements needed to calibrate value reflect “best guesses” of future revenues, expenses, timing, and investment requirements. 3.
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