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The 4 Myths of
"Value"
Value is Clear
Value is Consistent
Value is Constant
Value is Only for Transactions
What is the value of 1,000 lbs. of gold?
Some historical gold prices:
1950’s, 1960’s, early 1970’s - $35 per ounce
early 1980’s - $800 per ounce
late 1980’s through 1997 - $300 to $400 per ounce
Fall, 1997 - $280 per ounce
What is gold worth?
If you were leaving a sinking ship, would you swim with your 1,000 lbs. of
gold or leave it behind?
If you were in the desert with only your gold, would it have any value? Could
you eat it or drink it? If there were other people with you, could you trade it?
Why or why not?
What value would you input into the Capital Asset Pricing Model?
IT’S ALL IN YOUR HEAD!
Different levels of hockey
rat hockey
league hockey
play-off games
There is no way to reconcile the measurable, quantifiable risk with the
perceived risk. What do you input into the Capital Asset Pricing Model?
The structure of the deal is based on the values assigned by
each party
Value is a
function of Perceived Risk
and Perceived Reward
Components of a Deal
Who are the players
What are their goals
and objectives?
How do they perceive and
manage risk?
How do they perceive and
manage problems?
How do they get their information?
How credible and complete is it? How much uncertainty
is there?
How will their claim be valued under different
circumstances?
What are the current and expected rules and
context
(tax law, state of economy, capital markets, etc.)
How do you perceive risk and reward?
Fortune telling
Measurement criteria
monetary
lifestyle
psychic
Degree of risk aversion or preference
Time frame
Risk - why do entrepreneurs seem to take more?
Study cited in the Economist
100 Entrepreneurs, 100 Corporate Managers
Medical questions they had no knowledge of
Both groups scored the same
Managers’ confidence in their answers was 50%
Entrepreneurs’ confidence in their answers was 90%
Entrepreneurs perceive risk differently than managers
Important Things to Venture Investors
Getting their money back.
Getting their money back.
Getting their money back.
All of your goals, dreams, plans, aspirations, needs, talents, experiences,
ideas, abilities, insights, contacts, education, energy, investments, etc. don’t
mean a thing to the investor if they won’t help the investor at least come out
whole, and hopefully with a return.
They are not interested in financing you being out on your own, making your
life meaningful, or taking risks.
Entrepreneurs and people with money often have very different perceptions of
risk:
Entrepreneurs frequently have nothing to lose
Lenders have absolutely no upside, but demanding bosses
Investors with cash got that way by holding on to their money. They have
lifestyles to support.
How do you value potential deals?
Information needed?
Is it obtainable?
If so, at what costs?
Trade-offs to be made?
Tolerance for uncertainty
Potential risks, probability of occurrence
Potential rewards, probability of occurrence
Structuring a Deal
Value is hard to
determine.
Risks and Rewards
are not always apparent.
Risks and Rewards have different
meanings to different people.
Perceptions
change
Perceptions are not always accurate. They depend to a large part on
each
individual’s prior experiences and beliefs.
Each of us can have different answers to the same question, based on how
our prior
experiences and beliefs impact our perceptions.
V.C. Valuation Method
Projected profit or cash flow X years out
less discount for risk and uncertainty
= adjusted profit or cash flow.
less tax = post tax value
x Multiple
=Future equity value
V.C. Valuation Method (cont.)
Future Equity Value
x Present Value Discount Factor
= Present Value of Equity
V.C. cash invested / P.V. of Equity = V.C.’s percentage of the company.
What ever is left after the high uncertainty factor, high discount rate, etc.
belongs to the entrepreneur.
Discount Rates
Strategic Investors want 20% IRR
Venture Investors want 30% - 60% IRR, home
runs of 5x - 10x their investment
Compare to:
Home equity - Prime (~ 8%)
Asset based loan - (Prime + 1, 2, or 3%) + fees
Master Card, Visa - 14% - 22%
If you are 90% certain that you are right, it is very easy to ignore the
downsides of increased personal exposure and be seduced by the lower rates of
using your own $.
Other people’s money is expensive, but lowers your risk and provides you
with motivated partners.
Pricing Methods
(assigning
value)
Net Worth - book value or
adjusted book value (goodwill, intangibles adjustments)
Assets -
liquidation value (auction fire sale)
fair market value (professional appraisal)
replacement cost (go shopping)
Income
historic earnings x a multiple
future earnings x a multiple
future earnings, new owner, x a multiple
More Pricing Methods
Cash Flow
Payback method
Discounted cash flow
Adjusted cash flow (include salary, perks, fringes, etc.)
Cash flow times a multiple
Market Methods
Last trading price (if there was one)
Current competitive bids (or what they would likely be)
Comparable company prices
Special formulas in some industries
Still More Pricing Methods
Sales - trends,
multiples, etc.
Heuristic Methods
Intuitive value to buyer (including job, independence, learning, and other
personal satisfactions versus sacrifices and risks)
Strategic value (synergies with existing ventures)
Seller’s preconception of price (buyer can yield on this and make it back
on terms)
Terms (full buy-out)
Cash down payment
Installment payments (interest rates, due dates)
Guarantees of payment
Guarantees of performance, contingent payments
Stock payments
Options
Additional Terms (investor or lender)
Fees and expenses - who pays what, when, and how often
Priority
Security, non-subordination, etc. for lenders
Preferred, anti-dilution for equity
Performance collars or incentives - puts, options, warrants, formulas, etc.
Control
Board seats, ownership percentages, etc.
Restrictive covenants, asset ratios, etc.
Yet More Terms
Convertibility between equity and debt
Liquidity -how fast can interest be sold?
Exit penalties, repurchase agreements, etc.
Terms and prices of subsequent money
Rights of first refusal
Employment agreements, compensation, scope of duties, etc.
The dreaded personal guarantee
Other Conditions
Rights and obligations assumed or not assumed
Seller’s warranties (clear title, valid financials, no undisclosed
liabilities, authority to transact, etc.)
Durations or warranties and representations
Adjustments to be made at closing
On going obligations of either party (customer care, etc.)
Non-competes, employment agreements, etc.
Arbitration of disputes
Other Factors
Timing - business
condition, market conditions, etc.
Agents, Brokers, etc.
Disclosures - potential
buyers, employees, vendors, etc.
Tax structure of the deal
Bottom Line
Seller and buyer, or owner and investor, have different
needs
and perceptions.
Everything is negotiable.
A deal is made when each party is comfortable with the
risks
and rewards
they perceive within the total
package of price and terms.
How to reduce the uncertainty factor
Experienced management team
Well thought-out business plan.
Anticipate everything
Understand all the interrelationships
Detailed yet concise. Lots of back-up available.
Assumptions are consistent with reality
Prove the concept works - projections have a historical basis. Provide
tangible evidence.
Ratchet deals - ownership percentages vary within a collar of ranges based on
performance
Get the money when you don’t need it - no impending BK
Biggest Mistakes I’ve Seen
Turning down deals as too expensive (100% of nothing is nothing).
Pigs
get slaughtered.
Waiting until it is too late to get help
Business Plan not thought through well
"Nobody else knows / understands this as well as I do"
"Only
I can see the value in this."
Getting hung up on sunk costs. They are history. Don’t turn down money for
tomorrow just because it ignores what you put in yesterday.
More mistakes
Not realizing how much time and money it costs to raise money.
Impatience, giving up too much at the closing strokes (letting the lawyers
take over the deal)
Wasting time with the wrong investors
Being certain that there is money out there for this project
Being too afraid that there is no money out there for this project.
Using advisors with good reputation but questionable skills. Huge fees for
little or detrimental help.
Even more mistakes
Ignoring taxes (should be considered from day 1)
Not having a walk-away decision point
Not having a back-up plan that allows you to walk away.
Becoming a deer in the headlights - too afraid to take any action.
Being afraid to ask for what you really want.
Biggest Mistake
Never trying something you really, really, really, really want to do. You’ll
never know if you don’t try.
"you gotta be in it to win it"
| 
Michael Goldman & Associates, L.L.C. - Consulting
& CPA Services 
