In the past few weeks, I have met several founders whose DCF valuations for their early start-ups were made by “independent” third parties. These so-called “independent” 3rd parties are chartered accounts (CAs), certified financial analysts (CFAs) and the like. Their independence went out of the window the minute they took a financial obligation from the start-ups or the founder to value their companies, so I am already agitated when founders come in and show me these rubbish reports.
What really gets me worked up is how founders blindly rely on these valuations and go out claiming these absurd numbers, without even knowing how these reports were calculated. I can teach a 6-year-old child some simple questions to rip apart these nonsensical reports and expose how little the founders really understand them.
Why founders waste their time, money and effort to get these reports is stretching my patience and I am half inclined to encourage them to sue these 3rd party vendors. Founders need to understand that valuing an unlisted venture is a difficult task and even more complicated when the venture is in its early stages.
Therefore, my advice to every founder is to answer these 2 essential questions:
- What is the bare minimum amount of money they need for 18 months?
- How much buffer/contingency have they put into that calculation?
Post this, they need to understand that the incoming investor is looking at acquiring 15-25% of the venture to make it worth the risk of investing. No fancy report made by any valuation expert is going to convince any experienced early-stage investor otherwise.
If you still wish to understand how DCF works, please go through http://pages.stern.nyu.edu/~adamodar/ where a real-life guru of valuation is imparting his vast knowledge on the topic.
For further reference on my thoughts about early-stage investing you can read these posts from last year