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Valuation strategies for high-growth companies

Today we live in a disruptive world. We are seeing early-stage or disruptive companies emerging in large numbers across multiple industries, and valuing these businesses is often not as straightforward as it has been in the past for traditional companies.

In former times one would expect ownership of a minority stake in a private company to be valued at a significant discount to its equity value (the ‘minority discount’). This is no longer necessarily true in a world where investors are all trying to get a little piece of the pie and put a bet behind an increasingly diverse range of opportunities. Rather perversely, owning a small stake in a company now has a relatively higher attractiveness to an investor simply because they have diversified their risk.

When considering valuations of high-growth businesses, it is important to first fully understand the difference between value and price. When we talk about value we are in effect asking ourselves what the asset or the opportunity is actually worth to the investor. Price, on the other hand, is a measure of what the market will actually pay for a particular asset. Firms should be aware that value and price are not always equal, and that there may be a ‘gap’ to deal with.

In traditional businesses, we would expect to see cash flows projecting upwards over time with some variation in possible outcomes. However, for start-up companies the profile of potential outcomes and cash flows is fundamentally different – that is, investors have to grapple with fundamentally different business propositions. Typically early-stage businesses see lots of downside (i.e. losses) early on as they invest large sums of capital to develop the business, but the upsides they expect to see further down the line are even greater than for their traditional counterparts. Investors are having to factor this uncertainty into their pricing, which has the result of producing a very wide range of valuations for these companies.

Also, firms should be aware that valuation approaches come and go over time as businesses evolve. For a company in the seed stage of growth, valuation may revolve around replacement cost as the company is still to prove out its business case. As the company grows and becomes profitable, milestone-driven outcomes, market-based methodologies and discounted cash flow methodologies all take precedence for valuation purposes. Firms should be cognisant of where they are in their company lifecycle and therefore which methods a potential investor is likely to use.

If these themes resonate, visit www.deloitte.co.uk/CFOAdvisory for resources, insights and upcoming events.

Investment trends and valuation strategies