DARE - Because Entrepreneurs Do

This piece explores how to calculate the venture capital infusion required for running a profit-making company. What we discuss here is one possible approach. There are many others

Consider this scenario: You have been running your own setup for some time now, say four-five years, and have a decent product and a decent client list. Cash-flows are not that great, but are manageable and you make decent profits too. You have heard a lot about venture capital and are tempted to approach a potential funder. The question is, how much do you ask for.

This piece will attempt to convert the black art of determining how much to ask your venture capitalist into understandable thumb rules. But before that, a disclaimer—the numbers I have used are only for illustration and will vary depending on industry, stage of your business, state of the economy and so on.

Before we get into the calculations, you need to be clear about some basics. Firstly, we are not going to be bothered so much about turnovers and profits as much as we are going to be bothered about valuation. While valuation is linked (in some unseen, complex way) to these two numbers, it is a completely different beast. Valuation is the amount someone will pay to buy your company, lock stock and barrel, and is best expressed as market price of a share in your company x total number of shares. It also takes into account factors like future prospects, brand value, etc. So, how do you find out the value of your company?

Assuming that you are profit-making, a quick and dirty estimate of your value can be had from the P/E ratio (share price/earnings per share) of listed companies in your sector.

For example, let’s say that the average P/E ratio of your industry is 24 and that you have a profit after tax (PAT) of Rs 1 crore and a share capital of Rs 50 lacs.

So, in your case, price per share/earnings per share = 24.

Your current earnings per ten rupee share = Rs 1 crore/(50 Lac/10) = Rs 20.

Thus price per share/20 = Rs 24. Therefore, expected price per share = 20 x 24 = Rs 480.

Therefore current value of your company = 480 x 5 lac shares = Rs 24 crore.

Note that we have taken an industry average P/E. Depending on how conservative or aggressive you want to be, you can take a P/E at the higher or lower end of the industry spectrum.

There are a couple of other things you can add at this point to increase valuation. These include a value for any brand name you have created, a value for marquee clients you may have, value for any intellectual property you may have registered in the company’s name and so on. For purposes of simplicity, I am ignoring these additional valuations.

Now, if business were to continue as usual, where would your company be five years down the line? After detailed calculations, let’s assume that your company would be doing a profit of Rs 3 crore on the same capital base five years from now. This converts to a valuation of Rs 72 crore, assuming the same P/E.

The whole premise behind the injection of venture capital is that you are not happy with this Rs 72 crore valuation five years down the line, and want to increase it manifold. The injected capital will be used for achieving this.

Time to start dreaming! How much do you want the valuation to become? Let’s say that your target is Rs 500 crore (this has to be many times the current projection of Rs 72 crore for the VC route to be successful).

Comments (7)

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Interesting &informative article
written by Shawn, May 20, 2011

I'm new to this so the article was very interesting and helpful. I am not used to using my brain so much, I spend a lot of my time on the soccer field in my Adidas F50 cleats, so this article used my brain some.

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VC data base for Biotechnology start-ups
written by Dr. Arunkumar, January 28, 2010

I had the privilage of getting to the particular copy of the DARE and there after i had been regulerly reading your exceptional magizine and with the thumping article. It serves a right blend for the beginer's as well as as a reality checks of the basics for the pioneers. However i find that most of the issues are spoken in the angle of Entrepreneurship alone. I wish if there are articles coming up focussing the sector wise focusing on the business in each of the sectors. I also wish to know if there exist a database search or a database for the Venture funding for Biotechnology start-ups. I also wish to know how i can get your back volumes for my archive learners library?
arun

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re: Sanjay Modi
written by Krishna Kumar, July 17, 2009

Hi,

Supermarkets, hypermarkets , retail chains - the nearest group of listed companies is retail . http://portfolio.rediff.com/quotes/retail gives you some listed retail companies. You can easily find out the P/E ratio of these companies.
Alternately you could consult an expert on the stock markets. Hope that helps

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Average P/E Ratio
written by Sanjay Modi, July 17, 2009

"the average P/E ratio of your industry is 24 " I would Like to know the average P/E ratio of Supermarkets and Hypermarkets chain of stores and also for Garments retail chain stores. and secondly, where can i get this P/E ratio of other industries also? Thanks & Warm Regards

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Valuations for Startups
written by Yameer Adhar, March 09, 2009

Great article Mr Kumar. Would be great to get some more information regarding value for any brand name, clients intellectual property. Undoubtedly valuing a company is not an easy thing to do which often leads to a lot of under as well as over valued companies.

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How much should you ask your VC for ?
written by DHANANJAY KULKARNI, September 20, 2008

It was a very good presentation from Krishna Kumar overall,most important is the reality check 3.Normally performance and projections are very good for the first 2 years,it is very important to sustain the growth as per the projections.Most of the entreprenuers would like to be very optimistic about the growth and one has to be,to succeed.

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