Tuesday, December 16, 2014

Valuation of Young Firms

 Young companies share some common attributes:
  • No historical performance data.
  • Small or no revenues with probable operating losses.
  • High failure rate. Many don't survive.
  • Investments are illiquid. A significant portion of the equity is usually held by the founders.
Thus, there are no easy valuation solutions to the young firm problem. However here are some value drivers to look for when investing in young firms:
Revenue growth: This show how much growth potential the firm has.

Reinvestment for growth: A young company can (or even should) lose money in order to make money in the future. The managers / owners / founders should aim for long-term goals.

Survival skills: For young firms to become valuable, they simply need to survive. This requires talented management.

Key people: Young companies, especially in service business, are often dependent upon the owner or a few key people for their success. Focus on firms that have built up a solid bench to back up key personnel.

Corporate success: Sometimes success in one business or market can be a stepping-stone to success in other businesses or markets.

Exclusivity: Success attracts competition. You want young firms that have products that are difficult for others to imitate (patents, technology, or brand name).