Valuation: More art than science, more so in case of a startup
Valuation, in itself, poses enough procedural and technical challenges that in spite of all the various valuation methodologies, which are technically robust in their own rights, valuation is regarded more of an art, than a science.
In case of a listed or a larger entity with established record of profitability and/or cashflows, especially in cases where comparable industry data is available for benchmarking, the science of valuation plays a prominent role. But, in case of startups there is little, if any, history and a very wide open canvas of what it can grow to be. It is not unexpected to assume that in case of startups as the actual performance of the company will substantially vary from the projected one. Hence, DCF approach, which may be relevant in certain cases, will not hold water in such cases where the degree of certainty of projected cashflows is highly circumspect. Hence, any value ascribed to it might as well be arrived at by rolling the dice. The odds are pretty much the same!
Nevertheless, it cannot be ignored that the biggest test of valuation is common sense. If the valuation methodologies throw up a figure which either defies logic or which sounds too good to be true, it most probably is!

Rule of thumb
As investors move along the learning curve, having invested in numerous startups, they tend to form a feel and hence thumb rule of what kind of valuations DON’T make sense. Of course, with time and euphoria, these rules of thumb also tend to change. This may sound arbitrary and a highly subjective methodology of valuation. Albeit, there is enough empirical evidence to prove that any investment in a startup at a value of higher than the US$ 1m to US$ 2m has a thin statistical chance of making for a good investment for the investor. Hence, the early stage investor will always be wary of investing at a value higher than this range.
Would be useful to always bear in mind another golden rule of valuation of startups: he who has the gold makes the rules! So, it doesn’t matter what the entrepreneur think his business is worth. What the investor thinks as the businesses worth is what matters. After all, a business is worth only as much as what an investor is willing to write a cheque for!

Pre- and post-financing valuations
The pre-investment (a.k.a pre-money) valuation is the value at which the new investor comes into the business. It is the value of the business before the new investment is taken in. As a corollary, the post-investment valuation (a.k.a. post-money) valuation is the value of the business after the new round of funding/investment has come in.
Say, for e.g., a VC fund invests $500k for a 20% stake in a company, then the existing shareholding would amount to being 80% of the company. If 20% is valued at $500k, then the balance 80% would be proportionately valued at $2mn. Thus, the pre-money valuation of the company is $2mn and the post-money valuation is $2.5mn. Instead, if the VC fund had invested $500k for a 25% stake in the company, the pre- and post-money valuations of the company would be $1.5mn and $2mn respectively.
Albeit, it is pertinent to note that the pre- and post-money valuations are both an implied derivative of the amount being invested by the investor and the stake acquired by him against that investment.

Conclusion
From an entrepreneur’s perspective, valuation indeed is important, as it will determine what stake of his/her company will need to be diluted in favour of the investing stakeholders. But, its importance is oft-times over-rated. Its better to have a small pie of a large cake than be saddled with a very large pie of a rather small cake.
Would like to sign off with a small word of advice to all startups. If you have the right investing partner (smart money), focus on ‘value’ rather than valuation! Rather, if you are very confident of your business’ ability to grow, settle for a lower valuation if you have to for the sake of the fund-raising, but ask for milestone-based MSOPs. This will enable you to increase your own value, without compromising that of the investors. Of course, it would not be out of place to mention here: the value of the promoter’s holding is also a misnomer of sorts. In almost all cases, the promoter will be bound by legal restrictions to be able to cash out his position, unless all others have been given an opportunity to exit first.

In the Forex workshop (12Apr09), we had discussed against using the forward rate (F), as compared to the spot rate (S) in the denominator for calculating the depreciation/ appreciation of a currency, whereas some students had come up with an argument (duly supported by printed material) that ‘F’ instead of ‘S’ could be used.  Well, neither side was wrong.  BUT, repeat BUT, please be careful that you completely understand the logic of the argument/formula, and the way it is to be used.

For e.g., if INR per USD moves from INR 50 to INR 40 in one year, it means that as per the formula (F- S)/S, Rupee has appreciated (since the sign is ‘plus’) by 25%, being (50-40)/40 = 25%.  However, if we change the denominator to F, we will get the depreciation (opposite movement) of USD – the foreign currency.  That is, (F – S)/ F in case of direct quote, will give us the quantum of the opposite direction movement of the foreign currency – depreciation of 20% in the example we have just taken.  You can cross-verify the tenability of this answer by converting the quotes into direct quotes for USD, and using the (F-S)/S formula and you will get to the same answer.  This is a cool short cut, but make doubly sure you understand the logic.

Feel free to write to me if the above is not self-explanatory.  Comments are anyways welcome.

Reading has always been a passion since childhood.  What started with comics, moving on to novels (ah, the Chase, Ludlum, and Grisham days!) has now grown to a full fledged reading habit, with bulk of the time reserved for business books.  This is just an indicative list (from what I can recall from memory) of the books that I have read.  And a list of books that I would like to read.  Lenders welcome.

Books Already Read 

1. 24 Days, Rebecca Smith, John Emshwiller
2. 29 Leadership Secrets From Jack Welch, Robert Slater
3. Blink, Malcolm Gladwell
4. Business @ Speed Of Thought, Bill Gates
5. Confessions Of A Wall Street Analyst, Dan Reingold & Jennifer Reingold
6. Conspiracy Of Fools, Kurt Eichenwald
7. Dirty Rotten CEOs, William Flanagan
8. Disney War, James Stewart
9. Fedex Delivers, Madan Birla
10. Go Kiss The World, Subroto Bagchi
11. Iaccocca, An Autobiography, Lee Iacocca
12. Idiots At Work, Leland Gregory
13. If God Was A Banker, Ravi Subramniam
14. iWoz, Steve Wozniak
15. Jack Welch And The Ge Way, Robert Slater
16. Jack, Straight Form The Gut, Jack Welch
17. Lee Iacocca’s Talking Straight, Lee Iacocca
18. Losing My Virginity, Richard Branson
19. Made In America, Sam Walton
20. Made In Japan, Akio Morita
21. Mavericks At Work, William Taylor & Polly Lebarre
22. My Experiments With Truth, Mohandas Gandhi
23. Nuts, Kevin Freiberg, Jackie Freiberg
24. One Up On The Wall Street, Peter Lynch
25. Rich Dad Poor Dad, Robert Kiyosaki
26. Screw It, Lets Do It, Richard Branson
27. Storms In A Sea Wind, Alam Srinivas
28. Straight From The Gut, Jack Welch
29. The Alchemist, Paulo Coelho
30. The Amul India Story, Ruth Herediya
31. The Dhandho Investor, Mohnish Pabrai
32. The Eye Of The Storm, Robert Slater
33. The Fish Philosophy, Stephen C. Lundin, Harry Paul & John Christensen
34. The Intelligent Investor, Benjamin Graham
35. The Polyster Prince, Hamish Mcdonald
36. The Road Ahead, Bill Gates
37. The Scam, Debashis Basu & Sucheta Dalal
38. The Secret, Rhonda Byrne
39. The Starbucks Experience, Joseph Michelli
40. The Tipping Point, Malcolm Gladwell
41. The Toyota Way, Jeffrey Liker
42. The World Is Flat, Thomas Friedman
43. Who Moved My Cheese, Spencer Johnson
44. Who Says Elephants Cant Dance?, Louis Gerstner
45. Who Will Cry When You Die, Robin Sharma
46. Winning, Jack Welch

Books I Would Like To Read

1. Accidental Investment Banker, Jonathan Knee
2. Ask And It Is Given, Ester & Jerry Hicks
3. Awaken The Giant Within, Anthony Robbins
4. Buffetology, Mary Buffett
5. Built To Last, Jim Collins
6. Bull – History of Boom & Bust, Maggie Mahar
7. Business Stripped Bare, Richard Branson
8. Business The Richard Branson Way, Des Dearlove
9. Buy The Rumour, Sell The Fact, Michael Maiello
10. Den Of Thieves, James Stewart
11. Driving Change, Wind & Main
12. Every Second Counts, Lance Armstrong
13. Final Accounting, Barbara Ley Toffler & Jennifer Reingold
14. Financial Crime & Corruption, Sam Vaknin
15. Financial Self Defense, Charles Givens
16. Five Point Someone, Chetan Bhagat
17. Following The Money, George Benston, M Bromwich, R Litan & A Wagenhofer
18. Games Indians Play: Why We Are the Way We Are, V. Raghunathan
19. Good To Great, Jim Collins
20. Guts, Jackie & Kevin Freiberg
21. Hidden Financial Risk, J. Edward Ketz
22. How Starbucks Saved My Life, Michael Gates Gill
23. How To Get Rich, Donald Trump
24. Inconvenient Truth, Al Gore
25. Inside Arthur Andersen, Susan Squires, Cynthia Smith, L Mcdougall & W Yeack
26. Investment Fables – Myths Of Cant Miss Investment Strategies, Aswath Damodaran
27. Iron Triangle – Inside The Secret World Of Carlyle Group, Dan Brody
28. Its Not About The Bike, Lance Armstrong
29. Liar’s Poker, Michael Lewis
30. Manias Panics And Crashes, Charles Kindleberger
31. Merchants Of Deception, Eric Scheibeler
32. Now, Discover Your Strengths, Marcus Buckingham
33. Predators Ball, Connie Bruck
34. Surviving the Cataclysm, Webster Tarpley
35. Take On The Street, Arthur Lewitt
36. The Black Swan, Nassim Nicholas Taleb
37. The Blue Ocean Strategy, W Chan Kim & Renée Mauborgne
38. The Google Story, David Weise
39. The High Performance Entrepreneur, Subroto Bagchi
40. The Informant, James Stewart
41. The New Reality of Wall Street, Donald Coxe
42. The Oracle Bheind the Curtain, Alan Greenspan
43. The Real Warren Buffet, James O’Loughlin
44. The Real World Of Finance – 12 Lessons For The 21st Century, James Sagner
45. The Spirit To Serve, J W Mariott, Jr & Kathi Ann Brown
46. The Toyota Way, Jefferey Liker
47. The Wal Mart Way, Don Soderquist
48. Think And Grow Rich, Napolean Hill
49. What They Don’t Teach You At Harvard Business School, Mark Mccormack
50. When Geniuses Failed, Roger Lowenstein
51. Your Life Your Legacy, Roger Hamilton