Here’s an interesting little Valuation project in which we considered several growth scenarios and eventually found a value that everyone was comfortable with. The Company hired a new CEO last year and will grant 5% of its common stock to the new CEO. The question is, what is the value of that 5%?
Jonesco imports some products (manufactured in Asia, of course), but customized to its specs. Revenue grew from $50k in 2010 to $5 mil in 2012, a compound annual growth rate of 900%. They only increased by 100% from 2011 to 2012. They just passed through breakeven in 2012 and expected $500k EBITDA on $7.5 mil sales next year, slowing down to only 50% growth.
Here’s a little twist – the Company has grown to its present size with only about $50k in Equity. At first glance, the Company seemed severely underfunded, but it has $1 million in shareholder debt, illustrating the benefit of being rich before you launch a startup. And the Company has a lot more funds available to it that don’t happen to be on the books, yet. One nice thing about rich shareholder debt is, the lender is likely to be very accommodating. With its fantastic growth record, nice profit starting to show up, strong growth prospects, and reserve financing waiting in the wings, the value could be huge. On the other hand, with or without financing, growth could slow, or worse, it could all fall apart next year – it’s still a risky situation.
From a valuation perspective, there are several issues, bearing in mind that you only own 5%:
- The Company has a ton of “off-balance-sheet” equity, which is a little unusual – actually, a lot unusual. This reduces financing risk, but it also messes with the predictability of the capital structure. Furthermore, having that $1 million shareholder debt converted to equity would dilute a 5% shareholder to near invisibility overnight.
- The one controlling shareholder has the entire operation and the minority shareholder
- Their history is concise, so how much can we extrapolate from it? Historical earnings are useful only in that their trend suggests that $500k EBITDA next year is plausible.
So how did we come to a reasonable value? First, we assumed that the capital structure would remain as it was. If not, the CEO would presumably be out of there. We ran several discounted cash flow scenarios, testing continued strong growth and improving margins versus more moderate growth and lower margins, and got a fix on the value of each outcome. After a few iterations, the owner and the CEO agreed on a most likely scenario, made the stock grant, and we put the project to sleep. Will it wake up again?