younggrowth

younggrowth - 1 Valuing Young, Start-up and Growth...

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Unformatted text preview: 1 Valuing Young, Start-up and Growth Companies: Estimation Issues and Valuation Challenges Aswath Damodaran Stern School of Business, New York University adamodar@stern.nyu.edu May 2009 2 Valuing Young, Start-up and Growth Companies: Estimation Issues and Valuation Challenges Young companies are difficult to value for a number of reasons. Some are start-up and idea businesses, with little or no revenues and operating losses. Even those young companies that are profitable have short histories and most young firms are dependent upon private capital, initially owner savings and venture capital and private equity later on. As a result, many of the standard techniques we use to estimate cash flows, growth rates and discount rates either do not work or yield unrealistic numbers. In addition, the fact that most young companies do not survive has to be considered somewhere in the valuation. In this paper, we examine how best to value young companies. We use a combination of data on more mature companies in the business and the companys own characteristics to forecast revenues, earnings and cash flows. We also establish processes for estimating discount rates for private capital and for adjusting the value today for the possibility of failure. In the process, we argue that the venture capital approach to valuation that is widely used now is flawed and should be replaced. 3 Valuing companies early in the life cycle is difficult, partly because of the absence of operating history and partly because most young firms do not make it through these early stages to success. In this paper, we will look at the challenges we face when valuing young companies and the short cuts employed by many who have to estimate the value of these businesses to arrive at value. While some of the rules for valuing young businesses make intuitive sense, there are other rules that inevitably lead to erroneous and biased estimates of value. Young companies in the economy It may be a clich that the entrepreneurs provide the energy for economic growth, but it is also true that vibrant economies have a large number of young, idea businesses, striving to get a foothold in markets. In this section, we will begin by taking a look at where young companies fall in the business life cycle and the role they play in the overall economy. We will follow up by looking at some characteristics that young companies tend to share. A Life cycle view of young companies If every business starts with an idea, young companies can range the spectrum. Some are unformed, at least in a commercial sense, where the owner of the business has an idea that he or she thinks can fill an unfilled need among consumers. Others have inched a little further up the scale and have converted the idea into a commercial product, albeit with little to show in terms of revenues or earnings. Still others have moved even further down the road to commercial success, and have a market for their product or service, with revenues and the potential, at least, for some profits. service, with revenues and the potential, at least, for some profits....
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This note was uploaded on 12/01/2011 for the course FINANCE 350 taught by Professor Aswath during the Summer '10 term at NYU.

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younggrowth - 1 Valuing Young, Start-up and Growth...

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