Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups [1 ed.] 9783954895823, 9783954890828

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Jean-Baptiste Flanc

Valuation of Internet Start-ups

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An Applied Research on How Venture Capitalists value Internet Start-ups

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Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

Flanc, Jean-Baptiste: Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists Value Internet Start-ups. Hamburg, Anchor Academic Publishing 2014 Buch-ISBN: 978-3-95489-082-8 PDF-eBook-ISBN: 978-3-95489-582-3 Druck/Herstellung: Anchor Academic Publishing, Hamburg, 2014 Bibliografische Information der Deutschen Nationalbibliothek: Die Deutsche Nationalbibliothek verzeichnet diese Publikation in der Deutschen Nationalbibliografie; detaillierte bibliografische Daten sind im Internet über http://dnb.d-nb.de abrufbar. Bibliographical Information of the German National Library: The German National Library lists this publication in the German National Bibliography. Detailed bibliographic data can be found at: http://dnb.d-nb.de

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Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

Abstract This book deals specifically with the valuation of Internet start-ups after the burst of dot-com bubble. The objective is to contribute to the development of this field of study by filling some of the existing gaps. Indeed, it is a relatively recent subject, and the research devoted to it is still limited.

It has been found that the valuation of an Internet start-up does not only depend on its stage of development, but also on five qualitative factors: the team, the business model, the market, the risk, and the exit options. In fact, venture capitalists base their valuation on the perceived growth potential of the company.

Subsequently, this book addresses the issue of intangible assets. In fact, an Internet company derives most of its value from its intellectual capital, brand equity, and website. These intangible assets, as well as their accounting treatment, are deeply analyzed. It has been noticed the misclassification of their expenses can have a considerable impact on the valuation of the company.

The discounted cash flow valuation method, which is based on financial projections, and the relative valuation method, which is based on comparables, are identified and examined in-

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depth. Their analysis is crucial to determine how to properly value an Internet start-up.

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

Ce livre traite le sujet de la valorisation des start-up Internet, et ce, après l’éclatement de la bulle du secteur. L’objectif est de contribuer au développement de ce champ d’étude, qui est relativement récent, et dont les travaux de recherche sont limités.

Il a été constaté que la valeur d’une start-up Internet ne dépend pas seulement de son stade de développement, mais également de cinq critères qualitatifs: l'équipe, le modèle d'entreprise, le marché, les risques, et les options de sortie. Il s’avère en effet que les capitalrisqueurs évaluent une entreprise en fonction de son potentiel de croissance.

Une société Internet tire l’essentiel de sa valeur de ses immobilisations incorporelles : son capital intellectuel, sa marque, et son site. Le traitement comptable de ces immobilisations est donc analysé en détail. Il a notamment été remarqué qu’une mauvaise classification des dépenses liées à ces immobilisations peut avoir un impact considérable sur la valorisation de l’entreprise.

La méthode d’évaluation par l’actualisation des flux de trésorerie et la méthode d’évaluation par comparaison sont étudiés dans ce livre. Leur analyse permet de déterminer la meilleure

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façon d’évaluer la juste valeur d’une start-up Internet.

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

Acknowledgements

I hereby first and foremost express my great gratitude to Won Kim for its guidance and support. He was always available for discussions and suggestions about the different factors that could enter in the determination of the valuation of Internet start-ups.

I am very grateful to the venture capitalists who gave me relevant information on how they value this specific kind of companies.

Finally, I express my gratitude and thanks to my friends and family for their help and encour-

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agement throughout the development of this book.

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

Table of Contents

1.

2.

Introduction .................................................................................................................. 1 1.1.

Topic..................................................................................................................... 1

1.2.

Research Objectives ............................................................................................. 2

1.3.

Research Design ................................................................................................... 3

1.4.

Structure ............................................................................................................... 4

Overview and Definitions............................................................................................. 6 2.1.

The New Economy ............................................................................................... 6 2.1.1. Birth and Growth ................................................................................... 6 2.1.2. Pure Play Companies ........................................................................... 10 2.1.3. Winner-Take-All Competition ............................................................. 10

2.2.

The Development of Start-ups ........................................................................... 11 2.2.1. Stages of Development ........................................................................ 11 2.2.2. Funding Rounds and Sources............................................................... 13 2.2.3. Introduction to Valuation ..................................................................... 15

2.3.

The Venture Capital Funding ............................................................................. 17 2.3.1. Venture Capital .................................................................................... 17 2.3.2. Investment Criteria............................................................................... 19 2.3.3. Ownership Dilution .............................................................................. 27

3.

Dealing with Intangibles Assets ................................................................................. 30 3.1.

Identification ...................................................................................................... 30

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3.1.1. Intellectual Capital ............................................................................... 30 3.1.2. Brand Equity ........................................................................................ 32 3.1.3. Website................................................................................................. 34 3.2.

Expenses Misclassification and Other Characteristics ....................................... 35 3.2.1. R&D Expenses ..................................................................................... 36 3.2.2. Marketing and Advertising Expenses .................................................. 37 3.2.3. Other Characteristics ............................................................................ 38

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

3.3.

Accounting Treatment ........................................................................................ 39 3.3.1. Recognition .......................................................................................... 39 3.3.2. Fair Value Determination..................................................................... 40 3.3.3. Goodwill .............................................................................................. 40

4.

Financial Valuation Methods .................................................................................... 42 4.1.

Discounted Cash Flow Valuation Method ......................................................... 43 4.1.1. Forecasting Cash Flows ....................................................................... 43 4.1.2. Discounting Cash Flows ...................................................................... 44 4.1.3. Pros and Cons ...................................................................................... 46

4.2.

Relative Valuation Method ................................................................................ 47 4.2.1. Identifying Peer Companies ................................................................. 48 4.2.2. Comparing Multiples ........................................................................... 49 4.2.3. Pros and Cons ...................................................................................... 50

4.3.

Other Valuation Methods ................................................................................... 51 4.3.1. Probabilistic Methods .......................................................................... 51 4.3.2. First Chicago Method........................................................................... 52 4.3.3. Real Options Method ........................................................................... 53

Conclusion ............................................................................................................................... 54

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List of References ................................................................................................................... 56

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

List of Tables

Table 1: Internet Start-ups’ Standard Correlation .................................................................... 14 Table 2: Balance Sheet after Seed Round ................................................................................ 27 Table 3: Balance Sheet after Angel Round .............................................................................. 28 Table 4: Balance Sheet after Series A Round .......................................................................... 29 Table 5: Example of Relative Valuation for Internet Start-ups ............................................... 50

List of Figures

Figure 1: Number of Internet Users from 2001 to 2011 ............................................................ 7 Figure 2: Global Number of Internet Users from 2001 to 2011................................................. 8 Figure 3: Early Stages of Development of Traditional Start-ups ............................................. 12

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Figure 4: Qualitative Factors in Valuation ............................................................................... 19

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

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List of Abbreviations

CAPEX

Capital Expenditure

B2B

Business-to-Business

B2C

Business-to-Consumer

DCF

Discounted Cash Flow

FCF

Free Cash Flow

FV

Future Value

GAAP

Generally Accepted Accounting Principles

HTML

HyperText Markup Language

IAS

International Accounting Standards

IFRS

International Financial Reporting Standards

IPO

Initial Public Offering

IRR

Internal Rate of Return

Kd

Cost of Debt

Ke

Cost of Equity

Kp

Cost of Preferred

NOPAT

Net Operating Profit after Tax

NPV

Net Present Value

OPEX

Operating Expenditure

PV

Present Value

R&D

Research and Development

ROM

Real Options Method

VC

Venture Capitalist

WACC

Weighted-Average Cost of Capital

WWW

World Wide Web

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

Copyright © 2013. Diplomica Verlag. All rights reserved. Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

1. Introduction The following chapter will introduce the topic of this book, the research objectives, the research design, as well as the structure.

1.1. Topic In the last decades, the global economy has seen a shift away from manufacturing companies to service and technology companies. It should also be noted that this shift can be especially observed in the developed countries. With the emergence of the Internet industry, also known as the new economy, every existing company has been forced “to rethink its strategy and its place in the Internet world”1. In fact, the Internet is not only a business phenomenon, but also a social revolution.

With the increasing importance given to this new economy, the valuation of Internet companies has started to draw people’s attention. The dot-com crash in 2001 highlighted the weaknesses of the valuation methods applied at this time. In fact, investors lost a large amount of money, which makes them realize they needed to adjust the way they used to value Internet companies. The valuation of Internet start-ups after the burst of dot-com bubble is precisely the subject that will be analyzed and presented in this book.

Suppose that a business angel or a venture capital (VC) is interested in investing in an Internet

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start-up, the problem is to figure out what the company is really worth. In fact, it is at this moment that the valuation becomes necessary. The core issue to be answered is how this valuation should be done. It must also be noted that the Internet is one of the few industries where a company is worth something even if it is not profitable. Besides, when valuing a

1

Karen Southwick (2001), The Kingmakers: Venture Capital and the Money Behind the Net, New York, John Wiley & Sons, p. 26.

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

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start-up, what should be also kept it mind is that it does not matter what the founding team thinks the company is worth, it only matters what the potential investors think it is worth.

The valuation of Internet start-ups is still a relatively young subject of research. Nevertheless, it is becoming more and more important in today’s economy. The main issue that needs to be faced it that there is not a valuation method universally applied, which means that no one really knows how to value an Internet start-up. In fact, when asking VCs which is the best approach to value this kind of companies, they commonly agree that it is an open ended question and that unfortunately, there is not a simple answer. Indeed, the valuation of Internet start-ups is more art than science.

If there is an active market, this is to say if the company is listed on a stock exchange, the fair value is the market value. On the other hand, if there is no active market, this is to say if the company is not listed on a stock exchange, which is the case of all start-ups, the fair value must be estimated2. In order to do so, it is necessary to use one or more of the valuation methods detailed in this book. Notice that the two generally accepted methods for valuing Internet start-ups are the discounted cash flow (DCF) valuation and the relative valuation. An introduction on three other methods will be also given.

1.2. Research Objectives

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This book attempts to answer multiples questions: starting with the identification of the qualitative criteria that need to be considered when making an investment, ending with the examination and comparison of the different accepted valuation methods, and passing through the analysis and valuation of the most relevant Internet companies’ intangible assets. These

2

IPEV Board (2010), “International Private Equity and Venture Capital Valuation Guidelines”, IPEV Board, p. 11.

2

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

different points contribute all together to have an exhaustive and clear explanation of the valuation of an Internet start-up after the burst of the dot-com bubble, giving at the same time a significant contribution to this field of study.

1.3. Research Design Significant research has been conducted on both venture capital financing and valuation of start-ups. However, most of the studies are not specific to the Internet industry or are not updated to the current environment.

Ulrich Hege, Professor of Finance at HEC Paris, released in 2001 the article “L’Evaluation et le Financement des Start-up Internet”3, whose title can be translated in English as the valuation and financing of Internet start-ups. However, this study has been written during the burst of dot-com bubble; and therefore, does not cover the valuation methods that emerged after it. Among the multiple publications of the valuation expert Aswath Damodaran, Professor of Finance at the Stern School of Business at New York University, two have been very useful to the development of this book: the research report “Valuing Companies with Intangible Assets”4 published in 2009, and the book “The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses”5 published the following year. In spite of their contribution to the subject of valuation, Aswath Damodaran’s publications are not specific to Internet companies. Michael Jurgen Garbade published in 2011 at the University of Kassel the

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doctoral dissertation “Differences in Venture Capital Financing of U.S., UK, German and French Information Technology Start-Ups: A Comparative Empirical Research of the

3

Ulrich Hege (2001), “L’Evaluation et le Financement des Start-up Internet”, Revue Economique, Vol. 52, Numéro Hors Série: Economie de l’Internet, p. 291-312. 4 Aswath Damodaran (2009), “Valuing Companies with Intangible Assets”, New York University. 5 Aswath Damodaran (2010), The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, 2nd ed., Upper Saddle River, FT Press.

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

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Investment Process on the Venture Capital Firm Level”6. First, Michael Jurgen Garbade’s empirical research work is not focused on Internet start-ups. Second, it does not address the topic of valuation.

This book deals specifically with the indentified gap: the valuation of Internet start-ups after the burst of dot-com bubble. In fact, this work tries to fill in the inefficiencies and incompleteness of most current studies.

1.4. Structure In order to give an explanation of the valuation process of an Internet start-up, the book starts with an opening introduction, followed by an exhaustive body, and ends with a brief conclusion, which resumes what has been said and suggests future studies.

The main body of the study is structured in three chapters. Chapter 2 provides an overview of the valuation process, giving the definitions of the most significant terms and concepts related to the subject. This chapter focuses on the three following points: the Internet industry, also known as the new economy; the development of start-ups; and eventually, the venture capital funding. Each of these sections is then organized in three parts. For what concern the new economy, the study will concentrate on its birth and growth, focusing on the pure play companies, and examining its winner-take-all competition.

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In the case of the development of start-ups, the focus will be put on its different stages, on the sources and rounds of funding, and a preliminary explanation of the valuation process will be offered. The section about the venture capital funding talks about venture capital in general,

6

Michael Jurgen Garbade (2011), “Differences in Venture Capital Financing of U.S., UK, German and French Information Technology Start-Ups: A Comparative Empirical Research of the Investment Process on the Venture Capital Firm Level”, Ph.D. dissertation, University of Kassel.

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Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

explaining the criteria used when determining the potential of a start-up, and explain the concept of ownership dilution.

Chapter 3 is focused on the analysis of an Internet start-up’s intangible assets. This chapter examined the three following points: the identification of intangible assets, the misclassification of the expenses related to them, and their accounting treatment. Each of these sections is then organized in three parts. In the first section, the three main categories of intangible assets of an Internet company are identified: the intellectual capital, the brand equity, and the website. The next section explains why research and development (R&D), marketing and advertising expenses should be capitalized, and illustrates two other characteristics of companies which have a great amount of intangible assets. The section concerning the accounting treatment talks about the recognition of intangible assets, the determination of their fair value, and goodwill.

Chapter 4 analyzes and compares different financial valuation methods, with the aim to understand how a VC can determine the fair valuation of an Internet start-up. The two most accepted methods, which are the DCF valuation method and the relative valuation method, will be presented in details. This chapter is divided in three sections, and each of them is subdivided in three parts. The first section concerns the DCF valuation method, and examines its pros and cons. The same is done in the second section for the relative valuation method.

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And the third and last section provides a brief introduction on the probabilistic methods, the First Chicago method, and the real options method (ROM), presenting their main characteristics and uses.

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

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2. Overview and Definitions The following chapter will discuss three different, but related, subjects: the first section will give the history and explain the new economy, which is to say the Internet industry; the second section will illustrate development of start-ups; and the last section will explain the venture capital funding.

2.1. The New Economy This section is divided into three parts: the history of the birth and growth of the new economy; the description of pure play companies; and the explanation of a winner-take-all competition. 2.1.1. Birth and Growth It is important not to confuse the Internet with the World Wide Web (WWW), commonly called the Web. The Internet, which was created in 1969, has been defined as “the physical network that links computers across the globe”7. In fact, it is the system that interconnects computers and peripherals using a standard protocol. In other words, the Internet is a set of connections. The Web is a subset of the Internet, which only emerged in 1989 and is dedicated to broadcasting HyperText Markup Language (HTML) pages. Although the Internet and the Web are obviously not the same, it has become common to swap the words.

People only began turning to the Web with the release of the Web browsers8. Indeed, these

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software applications have enabled users to obtain access to information sources. Netscape was one of the first web browsers. The company was created in 1994 and went public in

7

Dave Chaffey (2007), E-Business and E-Commerce Management, 3rd ed., Essex, Pearson Education, p. 4. Ruthann Quindlen (2001), Confessions of a Venture Capitalist: Inside the High-stakes World of Start-up Financing, New York, Warner Books, p. 10.

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Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

1995. On the day of its initial public offering (IPO), the value of the stock doubled9. As a consequence, Netscape reached a valuation of $2.1 billion. Microsoft answered by launching Internet Explorer during the same year. In 1995, a student also founded Yahoo!, the search engine that became the uncontested leader between 1998 and 2000. Google, another search engine, was created in 1998. The new economy was born.

Figure 1 shows the growth of the Internet usage from 2001 to 2011. In developed countries, 29% of the inhabitants were already using the Internet in 2001. Ten years later, there were 74% of them. This is to say that in a developed country like France, three persons out of four are using the Internet. In the developing countries, the percentage of Internet users increased from 3 to 26%. According to figure 2, almost 2.5 billion people were using the Internet in 2011, which is more than one person in three. 100

Per 100 inhabitants

90 80 70 60 50 40 30 20 10

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0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Developed countries

29

38

41

46

51

54

59

61

65

69

74

Developing countries

3

4

5

7

8

9

12

15

19

21

26

Figure 1: Number of Internet Users from 2001 to 201110

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Ruthann Quindlen (2001), Confessions of a Venture Capitalist: Inside the High-stakes World of Start-up Financing, New York, Warner Books, p. 9. 10 “Internet Users”, International Telecommunication Union, http://www.itu.int/itu-d/ict/statistics/, consulted on April 18, 2012.

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

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Not onlly a businesss phenomeenon, but allso a sociall revolutionn, “the Interrnet is chan nging the way wee live”11. Inn fact, everyything has changed sinnce the birtth and grow wth of the Internet: from thhe way to coommunicatee, to the maanner of dooing businesss. Also nottice that thiis evolution is irrreversible, which meaans that goinng back is nnot an option, and the only o possibiility is to go forw ward.

100

3 3.000

90 2 2.500

70

In millions

2 2.000

60 50

1 1.500

40 1 1.000

30

Per 100 inhabitants

80

20

500

10 0 In millions Per 100 inhab bitants

2001 2002 20033 2004 20055 2006 20007 2008 200 09 2010 2011 495

677

785

914 1.023 1.151 1.37 74 1.575 1.80 05 2.044 2.4 421

8

11

12

14

16

18

21 1

23

27 7

30

0

35

Figu ure 2: Globaal Number of Internett Users from m 2001 to 201112

rnet industryy has been vvery cyclicaal. The firstt speculative bubble Since itts emergencce, the Intern took place betweeen 1995 and 2000 andd was calleed the dot-com bubble. This perriod was h market marked by exaggerrated expecttations of fuuture profitss. Analysts anticipatedd a very high

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A the heigh ht of the growth. Financing was widelly availablee and stock prices skyrrocketed. At m bubble, ruumors were enough to convince V VCs “to purcchase shares without an nalyzing dot-com results, debts, capittal structuree or costs, but b merely eexpectationss based on the t non-exisstence of 11

Karen Southwick (20001), The Kinngmakers: Vennture Capital and the Moneey Behind the Net, N New Yorrk, John Wiley & Sons, p. 27. 12 “Internnet Users”, Intternational Tellecommunicattion Union, htttp://www.itu..int/itu-d/ict/sttatistics/, conssulted on April 18, 2012.

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Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

any method of valuation for these types of companies”13. In fact, traditional valuation methods seemed to be irrelevant for the Internet industry, and most investors overlooked them. Internet businesses were then valued based upon the amount of traffic they attracted. This method led to excessive valuations. Many Internet entrepreneurs have made millions and billions out of unprofitable companies14.

The dot-com bubble finally burst in 2001. As a result, the whole Internet industry went into a crisis situation. Analysts and specialists have been highly criticized for being responsible for the excessive valuation of Internet companies15. It must be remembered that most of these companies had never made a profit. Since the dot-com crash, investors have suddenly become more cautious and reticent when valuing and financing Internet start-ups. This cut in the money supply has opened the door to another issue. Indeed, “many companies that needed to raise capital for investment found the capital market suddenly shut to them”16.

A few years after the dot-com crash, the Internet industry has moved towards the so-called Web 2.0. While the Web 1.0 had only focused on broadcasting information, the Web 2.0 was viewed as a means of interactive experience. Examples of Web 2.0 include social networks such as Facebook or Twitter. Notice that the emergence of this new version of the Web has

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seen a return to excessive valuations. Thus experts fear a new bubble, and most alarmingly, a

13

Carmen Lozano and Federico Fuentes (2006), “The Problems of Internet Company Financing: A Methodological Analysis”, International Research Journal of Finance and Economics, Issue 3, p. 92-100. 14 Eduardo S. Schwartz and Mark Moon (2000), “Rational Pricing of Internet Companies”, Financial Analysts Journal, Vol. 56, Number 3, p. 62-75. 15 Krishna G. Palepu and others (2007), Business Analysis and Valuation: Text and Cases, IFRS ed., London, Thomson Learning, p. 24. 16 Krishna G. Palepu and others (2007), Business Analysis and Valuation: Text and Cases, IFRS ed., London, Thomson Learning, p. 22.

Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

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new burst17. It has always been crucial for a company to be in the right place at the right time. But this is even truer in a cyclical industry such as the Internet industry.

2.1.2. Pure Play Companies In practice, there are only two types of Internet business models. The first one is called brickand-click and refers to the companies that incorporate both offline and online presences. The other type of Internet business model is called pure play and refers to the companies that only incorporate online presence. For example, while the French retailer Fnac, which has physical stores, is a brick-and-click company, Amazon.com, which does not have any physical stores, is a pure play company. As another example, Facebook, the famous social network, is also a pure play company.

As it has already been mentioned, this book aims to analyze, understand and explain how venture capitalists value Internet start-ups, and more specifically, pure play start-ups.

2.1.3. Winner-Take-All Competition The Internet has been recognized as a winner-take-all kind of business18. This means that in this industry the market leaders capture most of the profits, while the remaining competitors struggle to survive. Indeed, “profitability is confined to a very small number of Internet winners”19. It is therefore imperative for Internet start-ups to adopt aggressive strategies in

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order to conquer market leadership. This is to say, to invest massively in R&D, marketing and

17

“LinkedIn Doubles its Value on Day 1 of IPO - DotCom Bubble #2?”, ManagementDirect, http://www.managementdirect.com/resources/linkedin-doubles-its-value-on-day-1-of-ipo-dotcom-bubble2/?r=387/, consulted on May 11, 2012. 18 Tom Taulli, “Putting a Value on your Startup”, Forbes, http://www.forbes.com/sites/tomtaulli/2012/01/03/putting-a-value-on-your-startup/, consulted on March 17, 2012. 19 Thomas Noe and Geoffrey Parker (2005), “Winner Take All: Competition, Strategy, and the Structure of Returns in the Internet Economy”, Journal of Economics & Management Strategy, Vol. 14, Number 1, p. 141164.

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Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

advertising. In fact, competition between Internet start-ups often looks like a patent race20. Notice that a winner-take-all industry leads to the superstar valuations of the market leaders. For example, an Internet start-up that becomes a dominant player in its field will see its valuation increase rapidly and massively. This was the case of the professional network LinkedIn whose valuation skyrocketed because of the company’s leadership position. Once again, most experts believe that these superstar valuations are “losing touch with reality”21.

2.2. The Development of Start-ups This section is divided into three parts: firstly there will be a general illustration of the different stages of development of most start-ups, giving particular attention at the case of Internet start-ups, that follow their own evolutionary process; secondly the different funding rounds and sources will be identified and explained; and finally, a brief introduction about the valuation will be provided. 2.2.1. Stages of Development A start-up can be defined as a small new business. Therefore, a company that goes public or that is taken over by a competitor is not considered as a start-up anymore. Figure 3 shows the early stages of development of traditional start-ups, which are the idea stage, the start-up stage, and the second stage. It can be noticed that according to this figure, a company starts to generate revenue between the idea stage and the start-up stage. Then, the company improves its cash position and ends the second stage by reaching the breakeven point. While this

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classification is applied to most industries, the Internet industry is the exception. In fact, Internet companies do not have the same life cycle than traditional companies. They can move

20

Ulrich Hege (2001), “L’Evaluation et le Financement des Start-up Internet”, Revue Economique, Vol. 52, Numéro Hors Série: Economie de l’Internet, p. 291-312. 21 “LinkedIn Doubles its Value on Day 1 of IPO - DotCom Bubble #2?”, ManagementDirect, http://www.managementdirect.com/resources/linkedin-doubles-its-value-on-day-1-of-ipo-dotcom-bubble2/?r=387/, consulted on May 11, 2012.

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from one stage to another without making any revenue, which is only possible with venture capital funding.

Figure 3: Early Stages of Development of Traditional Start-ups22 Internet start-ups have five stages of development: the seed stage, the start-up stage, the second stage, the third stage, and the bridge stage. The seed stage is equivalent to the idea stage. As with traditional start-ups, “at this point there is a founder, some portion of a management team, and the idea for the company”23. To summarize, the seed stage is just business planning. Then, the start-up stage begins once the product gets to the market. This is to say, once the website goes online, even if it is only a prototype. The next stage, which is the second stage, is reached when “the start-up is growing (…) and is about to become an established market player”24. When this is accomplished, the Internet start-up goes to the third

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stage. The company is then considered as an important market player. Finally, the bridge

22

Aswath Damodaran (2010), The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, 2nd ed., Upper Saddle River, FT Press, p. 214. 23 Ruthann Quindlen (2001), Confessions of a Venture Capitalist: Inside the High-stakes World of Start-up Financing, New York, Warner Books, p. 199. 24 Michael Jurgen Garbade (2011), “Differences in Venture Capital Financing of U.S., UK, German and French Information Technology Start-Ups: A Comparative Empirical Research of the Investment Process on the Venture Capital Firm Level”, Ph.D. dissertation, University of Kassel, p. 56.

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Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

stage, also called the pre-public stage, is the last stage of development. The start-up is almost ready to go public. It might only need more time or more capital.

2.2.2. Funding Rounds and Sources Banks and insurance companies generally do not provide venture capital funding. In fact, it has been defined as the “capital provided for high risks that would not normally attract conventional finance”25. To be more precise, banks have completely stopped investing in Internet start-ups since the burst of the dot-com bubble. They rather finance companies with low risk of failure. This basically means that Internet start-ups are dependent on funding from private sources26, including business angels and VCs.

Business angels are wealthy individual investors that typically invest between EUR 5,000 and EUR 200,00027. Table 1 reveals that they put in money in the start-up stage of development. On the other hand, VCs only invest in start-ups that have reached at least the second stage of development, which is to say the companies that are becoming established market players. Unlike business angels, VCs can provide several EUR million. But if a start-up is very successful and needs even more capital than what most VCs can provide, it will be time for the company to go public.

Investors should look at how much capital the start-up will need across its life cycle. Howev-

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er, “you don’t know how long it will take the company to exit, how many rounds of cash it

25

Stephen Valdez and Philip Molyneux (2010), An Introduction to Global Financial Markets, 6th ed. New York, Palgrave Macmillan, p. 489. 26 Aswath Damodaran (2010), The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, 2nd ed., Upper Saddle River, FT Press, p. 215. 27 “Les « Business Angels » Veulent Séduire les Cadres Salariés et les Jeunes Investisseurs”, Les Echos, November 28, 2011, p. 27.

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will need”28. This means that it is never easy to determinate how much money is required to reach the last stage of development. And this is the reason why “the entrepreneur doesn’t have the leverage to do more than take what is offered”29, rather than ask for an amount that is not measurable and justifiable. Nevertheless, it is also true that Internet start-ups typically do not require a lot of capital to get started. But large expenditures on R&D, advertising and marketing are still needed to gain market shares.

It must also be noted that is unlikely for an investor to provide a start-up with as much money as it needs all at once30. But instead, the investor will offer to the new company just enough to reach the next stage of development. This is what is called a financing or a funding round. Seed, angel, series A, series B and series C are the terms commonly used to describe the different funding rounds.

Stages of Development

Rounds of Funding

Investors

Seed Stage

Seed Round

Founders, Families and Friends

Start-up Stage

Angel Round

Business Angels

Second Stage

Series A Round

Third Stage

Series B Round

Bridge Stage

Series C Round

Venture Capitalists

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Table 1: Internet Start-ups’ Standard Correlation

28

Carlos Eduardo, “How Does an Early-stage Investor Value a Startup?”, The DrawingBoard, http://thedrawingboard.me/2012/01/18/how-does-an-early-stage-investor-value-a-startup/, consulted on February 20, 2012. 29 Ruthann Quindlen (2001), Confessions of a Venture Capitalist: Inside the High-stakes World of Start-up Financing, New York, Warner Books, p. 170. 30 Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus (2009), Fundamentals of Corporate Finance, 6th ed., New York, McGraw-Hill/Irwin, p. 416.

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Table 1 shows the standard correlation between the stages of development of Internet startups, the rounds of their funding, and the different kind of investors they may have. However, “the financing rounds are not directly tied to the stage the company is in”31. This means that a start-up might be getting its angel round of funding while it is still in the seed stage of development. On the other hand, a start-up getting its series B round of funding may already be in the bridge stage of development. 2.2.3. Introduction to Valuation Based on its financial position, a start-up is worth next to nothing since it is rarely making any money. Although this is true with the companies of the traditional industries, it is different with the Internet. In fact, Internet start-ups often have significant expenses, but little or no revenues. As a general rule, what is valued is the market potential. However, the valuation of a company always depends of its stage of development. It seems logical that valuing a seed stage company is different to valuing a bridge stage company. In fact, it is virtually impossible to value a seed stage company since it is just an idea on study. Investing in start-ups in the seed stage represents the highest risk, but also the highest possible return. Indeed, “the earliest investors make the most money on investments”32. Families, friends, and business angels typically invest at a lower price than VCs. In fact, a start-up should be valued at a higher valuation when it enters the next stage of development. Also notice that while founders want their start-ups to be valued at higher prices, VCs prefer the opposite33. In fact, they will prefer to invest at lower valuations in order to earn greater shares of ownership for the same amount

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of capital invested.

31

Ruthann Quindlen (2001), Confessions of a Venture Capitalist: Inside the High-stakes World of Start-up Financing, New York, Warner Books, p. 198. 32 Ruthann Quindlen (2001), Confessions of a Venture Capitalist: Inside the High-stakes World of Start-up Financing, New York, Warner Books, p. 176. 33 Michael Jurgen Garbade (2011), “Differences in Venture Capital Financing of U.S., UK, German and French Information Technology Start-Ups: A Comparative Empirical Research of the Investment Process on the Venture Capital Firm Level”, Ph.D. dissertation, University of Kassel, p. 86.

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Pre-money valuation and post-money valuation are two specific terms that must be understood by every entrepreneur looking for funding. The pre-money valuation is what a start-up is worth before an investment. In other words, it is the valuation before the money goes in. Then, the post-money valuation is what a start-up is worth after an investment. It is the valuation after the investor puts the money in. The basic formula is as follows:

ܲ‫ ݐݏ݋‬െ ݉‫ ݊݋݅ݐܽݑ݈ܸܽݕ݁݊݋‬ൌ ܲ‫ ݁ݎ‬െ ݉‫ ݊݋݅ݐܽݑ݈ܸܽݕ݁݊݋‬൅ ‫ݐ݊݁݉ݐݏ݁ݒ݊ܫ‬

Let’s say, for example, that a potential investor and the founders of a start-up agree that its pre-money valuation is EUR 400,000. If the investor invests EUR 100,000, then the postmoney valuation would be EUR 500,000. The following calculation illustrates how to find the percentage of ownership that the investor would earn.

‫ ݌݄݅ݏݎ݁݊ݓܱݏ  ݎ݋ݐݏ݁ݒ݊ܫ‬ൌ 

‫݀݁ݐݏ݁ݒ݊ܫݐ݊ݑ݋݉ܣ‬  ሺܲ‫ ݁ݎ‬െ ݉‫ ݊݋݅ݐܽݑ݈ܸܽݕ݁݊݋‬൅ ‫݀݁ݐݏ݁ݒ݊ܫݐ݊ݑ݋݉ܣ‬ሻ

‫ ݌݄݅ݏݎ݁݊ݓܱݏ  ݎ݋ݐݏ݁ݒ݊ܫ‬ൌ 

ͳͲͲǡͲͲͲ ሺͶͲͲǡͲͲͲ ൅ ͳͲͲǡͲͲͲሻ

‫ ݌݄݅ݏݎ݁݊ݓܱݏ  ݎ݋ݐݏ݁ݒ݊ܫ‬ൌ ʹͲΨ

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Upround and downround are two other terms that are important to understand the valuation of start-ups. An investment is called an upround if the pre-money valuation of a company is higher than the post-money valuation of the previous investment. Let’s say, for example, that a VC provides a series A round at a post-money valuation of EUR 2 million. Six months later, another VC provides a series B round at a pre-money valuation of EUR 3 million. In this case,

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Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

the investment is an upround. If the start-up had raised the series B round at a pre-money valuation of EUR 1.5 million instead of EUR 3 million, the investment would have been called a downround. Each round of funding is typically done at a higher valuation. Actually, a successful start-up should only have uprounds until it goes public or it is taken over by a competitor. On the other hand, a downround is considered as a negative indicator that will damage the reputation of the start-up.

2.3. The Venture Capital Funding Although there are different kinds of investors, this book focuses on VCs, and more particularly, on how they value Internet start-ups. 2.3.1. Venture Capital To have a good initial idea is the most important element of an Internet start-up, but this is not enough to bring the company to success. In fact, great amounts of capital are required to take an idea from the business plan to a prototype, and also to finance large-scale marketing and advertising campaigns.

Venture capital has been defined as “private investment capital offered by professional firms to entrepreneurial start-ups in which the firms exchange cash for an equity stake in the company”34. In other words, VCs provide the money that start-ups need for their development; and in return, they receive shares of ownership in these businesses. VCs typically do

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not seek the majority of a company’s ownership; but rather, they target between 20 and 30% of it. The reason of this limitation is justified by their strategy. In fact, “the venture capital company puts in a mixture of equity and loans and hopes to make large capital gains later

34

Karen Southwick (2001), The Kingmakers: Venture Capital and the Money Behind the Net, New York, John Wiley & Sons, p. 21.

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when the firm obtains a flotation on the local stock exchange”35. This strategy implies that the VC does not take the control of the start-up in which it has invested. It also implies a high level of risk, to the point that the venture capital business can be compared to a lottery game. Many investments will be lost, but a few ones can generate large profits. Indeed, “VCs invest in 20 businesses with the expectation that one succeeds and will pay for all the other 19 failures”36.

The venture capital industry emerged in the 1960s in the U.S.37. At the time, private investors were investing mostly in technology start-ups based on the East coast. Then, the Silicon Valley, a region of California, became the leading hub for information technology companies including Internet companies. For example, the two most popular search engines, Yahoo! and Google, were created in the Silicon Valley and received venture capital funding throughout their development. In Europe, the venture capital industry was less developed than in the U.S. In fact, it only emerged in the 1980s and did not manage to catch up with the U.S. However, notable Internet companies, such as Skype, were also founded and financed in Europe.

Venture capital is one of the most important growth drivers for a start-up. The reason of this is that VCs are not passive investors. They do not only provide financial capital but also their deep industry knowledge, strategic advice and contacts. Indeed, a good VC will bring “human and social capital to their managerial expertise, experience and diverse industry networks”38.

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It is clear that once a VC has financed a start-up, it will do everything it can to maximize the return on investment (ROI). The VC that puts up the money will often require being on the 35

Stephen Valdez and Philip Molyneux (2010), An Introduction to Global Financial Markets, 6th ed. New York, Palgrave Macmillan, p. 121. 36 Manuel Stagars (2011), “Internet Startups Best Practice”, Bernsteyn Innovation, p. 4. 37 Spencer E. Ante (2008), Creative Capital: Georges Doriot and the Birth of Venture Capital, Boston, Harvard Business School Publishing, p. XVII. 38 Michael Jurgen Garbade (2011), “Differences in Venture Capital Financing of U.S., UK, German and French Information Technology Start-Ups: A Comparative Empirical Research of the Investment Process on the Venture Capital Firm Level”, Ph.D. dissertation, University of Kassel, p. 10.

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board of the company39. In fact, this is a way of controlling and monitoring the start-up. In some cases, VCs even end up owning the start-up by pushing the founders and early investors out. This scenario is actually quite common in the Internet industry. 2.3.2. Investment Criteria When it comes to VCs, it is estimated that “they invest in less than 1 percent of what they see”40. The question is then, how do they know an idea is a good idea when they hear it? In fact, they rely on a combination of qualitative factors. That is to say factors which are difficult to put a figure on. In fact, besides the stages of development, VCs can base their valuations on the analysis of qualitative factors such as the team, the business model, the market, the risk, and the exit options. This combination, which is shown in figure 4, is used to value start-ups in order to make investment decisions.

Team

Exit Options

Business Model Stage of Development

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Risk

Market

Figure 4: Qualitative Factors in Valuation

39

Manuel Stagars (2011), “Internet Startups Best Practice”, Bernsteyn Innovation, p. 3. Karen Southwick (2001), The Kingmakers: Venture Capital and the Money Behind the Net, New York, John Wiley & Sons, p. 30.

40

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•

The Team

The perceived strength of a team is a factor that enters in the determination of the valuation of any company41. In fact, it is the first thing that VCs value. They know that the success of a start-up depends on the effort its management team put in42. Indeed, one might argue that, all things being equal, the team will usually make the difference. For example, experienced entrepreneurs give VCs faith that they can execute. This is why inexperienced entrepreneurs will find it harder to raise funds. Also, some executives or engineers have their own independent value. It has been stated that “companies like Facebook and Google (…) often acquire companies for their talent, not their products or customers”43.

•

The Business Model

A business model describes how an organization plans to create value; this is to say, how it plans to make money. In fact, a business model is essential to every company. VCs always look at it when they value a start-up44. This is why the founders of a start-up who seek new capital must pay attention to the clarity of their business model. It must be quickly understood. The first thing to indicate is if the start-up is a business-to-business (B2B) or a business-to-consumer (B2C). It has also been stated that the business model of an Internet

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company must include eight elements: “customer value, scope, price, revenue sources,

41

Ruthann Quindlen (2001), Confessions of a Venture Capitalist: Inside the High-stakes World of Start-up Financing, New York, Warner Books, p. 169. 42 Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus (2009), Fundamentals of Corporate Finance, 6th ed., New York, McGraw-Hill/Irwin, p. 416. 43 Tom Taulli, “Putting a Value on your Startup”, Forbes, http://www.forbes.com/sites/tomtaulli/2012/01/03/putting-a-value-on-your-startup/, consulted on March 17, 2012. 44 “How Do I Value my Internet Start-up?”, Inc., http://www.inc.com/articles/2000/09/20360.html/, consulted on December 22, 2011.

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connected activities, implementation, capabilities and sustainability”45. Together, these elements should create a competitive advantage.

The revenue streams of a pure play company are mostly based on an advertising model. For example, social networks are often free to users. But “if you are using a service for free, you are not the customer – you are the product being sold”46. In fact, a Web 2.0 company does not only collect the online footprint of its users, but also their social relationships and their interaction history. They can then sell this information to advertisers. As a result, advertising agencies only have to buy space on the website to target the users who fit a specific profile. However, it has been stated that while “many start-up companies expected online advertising alone to make them profitable (…), the dot-com crash squashed many hopes, sending thousands of investors and start-up enterprises into bankruptcy”47. In some cases, advertising revenue is just enough to compensate the company’s own advertising expenditures. Revenue streams can also be based on a subscription model. This means that the customer will have to pay something to have access to the product or the service. For example, some online newsstudys and magazines require the customers to pay a subscription.

It should be noted that VCs will not invest in a concept or an idea. They are not early investors such as founders’ families and friends; they are professional investors who seek high returns. Therefore, they will make sure that the business model of the start-up is working and

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is sustainable. Indeed, the following advice can be found in some guidelines for Internet entrepreneurs: “you should put a very early version of your product online, and you should 45

Michael Jurgen Garbade (2011), “Differences in Venture Capital Financing of U.S., UK, German and French Information Technology Start-Ups: A Comparative Empirical Research of the Investment Process on the Venture Capital Firm Level”, Ph.D. dissertation, University of Kassel, p. 40. 46 Jonathan LeBlanc (2011), Programming Social Applications: Building Viral Experiences with OpenSocial, OAuth, OpenID, and Distributed Web Frameworks, Sebastopol, O’Reilly Media, p. 40. 47 Google (2007), “Marketing and Advertising Using Google: Targeting your Advertising to the Right Audience”, Google, p. 6.

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get at least some early adopters or fans using the product or service”48. Moreover, a working prototype will enable the potential VCs to assess the market potential.

•

The Market

The valuation of a company is always context specific, especially when it is an Internet company. The potential market, in terms of size and competition, is therefore another factor that enters in the determination of the valuation of a start-up. Indeed, VCs always look at the size of the market49. They want to be sure that the start-up is in a growing market, and not in a saturated market. Moreover, as it has been mentioned earlier, the Internet industry is a winner-take-all kind of business. This is to say that if a company is becoming a dominant player, its valuation will skyrocket. On the other the hand, if a company fails to capture a great amount of market shares, its valuation will not progress rapidly. Another element in the valuation of start-ups is “the balance (or imbalance) between demand and supply of money”50. As a general rule, in a bull market, there is an increase of the money supply. VCs tend to overvalue start-ups because they believe in the future turning out to be great. On the contrary, in a bear market, there is always a cut in the money supply, which results in the undervaluation of start-ups.

To sum up, the valuation of a company is dictated by the market forces of the industry in

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which it plays. This is why it is crucial to understand how the Internet industry is working in order to forecast what the future will bring.

48

Manuel Stagars (2011), “Internet Startups Best Practice”, Bernsteyn Innovation, p. 3. “How Do I Value my Internet Start-up?”, Inc., http://www.inc.com/articles/2000/09/20360.html/, consulted on December 22, 2011. 50 Carlos Eduardo, “How Does an Early-stage Investor Value a Startup?”, The DrawingBoard, http://thedrawingboard.me/2012/01/18/how-does-an-early-stage-investor-value-a-startup/, consulted on February 20, 2012. 49

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•

The Risk

Internet start-ups appear to be an extremely lucrative investment for VCs willing to absorb the risk. However, only a few VCs manage to balance the risks and rewards. Indeed, it has been estimated that, on average, no more than one out of four VCs earns money on their investments51.

The main risks associated with start-ups can be listed under three categories. The first one is the competition. In order to assess the risk associated with it, VCs can perform a Porter’s Five Forces analysis52. One of the aims in doing that is to check whether the competitors can copy the business model or not. The second category of risk is the scalability. In fact, any start-up has to find the right balance of investment to support its growth. The issue is to budget how much to spend on R&D, marketing and advertising. On the one hand, insufficient investment can result in the inability to gain market shares. On the other hand, too much expenditure in the early stages of development can undermine the financial health of the company. The last category of risk is associated with the customer learning curve. Once again, it might be necessary to do a lot of advertising to explain to the customers what the service is, and how to use it.

It can be noticed that B2B companies are less risky than B2C companies; and therefore, easier

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to value. In fact, it is easier to size a B2B market than a B2C market, since there is more available information about it. Moreover, unlike a B2B company, the success of a B2C company relies on customer emotions that are tough to predict. 51

Michael Jurgen Garbade (2011), “Differences in Venture Capital Financing of U.S., UK, German and French Information Technology Start-Ups: A Comparative Empirical Research of the Investment Process on the Venture Capital Firm Level”, Ph.D. dissertation, University of Kassel, p. 59. 52 Michael Porter (1998), Competitive Strategy: Techniques for Analyzing Industries and Competitors, New York, Free Press, p. 4.

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The level of risk also depends on the stage of development of the company. For example, a start-up stage venture deal is riskier than a second or third stage venture deal. However, if the company is successful, it would have been more interesting to have invested at the beginning of its development. The returns would have been higher. Once again, VCs must balance the risks and rewards. Risk always plays a big role in valuation. It has been stated for instance that VCs take into consideration “other prior investors in the company (if there are any), their reputations and investing history”53. In fact, prior investments by well-known VCs are perceived as a sign of confidence. In order to hedge the remaining risk, VCs typically require being able to monitor and to participate in the business decisions of the start-up54. As it has been mentioned earlier, VCs are not passive investors. They want to make large profits and will do everything they can help it.

•

The Exit Options

A start-up’s exit options are key factors in the determination of its valuation. Actually, it has been stated that “exit plays a very important role (…) because VCs chiefly realize returns only at exit”55. In fact, VCs always look at the likely exit of a company before investing in it. They

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want to know not only what the exit options are, but also their relative exit values.

53

Ruthann Quindlen (2001), Confessions of a Venture Capitalist: Inside the High-stakes World of Start-up Financing, New York, Warner Books, p. 169. 54 Michael Jurgen Garbade (2011), “Differences in Venture Capital Financing of U.S., UK, German and French Information Technology Start-Ups: A Comparative Empirical Research of the Investment Process on the Venture Capital Firm Level”, Ph.D. dissertation, University of Kassel, p. 95. 55 Michael Jurgen Garbade (2011), “Differences in Venture Capital Financing of U.S., UK, German and French Information Technology Start-Ups: A Comparative Empirical Research of the Investment Process on the Venture Capital Firm Level”, Ph.D. dissertation, University of Kassel, p. 112.

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o Initial Public Offering

A VC can sell its equity stake in a start-up through an IPO. It is then important to notice the distinction between a primary offering and a secondary offering. A primary offering is when the start-up issues new shares to raise additional capital. In this case, the IPO is used as a last round of financing. In contrast, a secondary offering is when the existing shareholders put their shares up for sale. This kind of offering is certainly the one that VCs prefer as it allows them to cash in some of their gains. Actually, it has been estimated that only 20 to 25% of the businesses that were funded by VCs go public56. However, these IPOs provide the most essential part of their profits. As a result, a start-up that plans to go public in the future is likely to get VCs’ attention.

Internet start-ups have been pioneers in early IPO. In fact, many companies that never paid dividends, that haven’t broken even, or even worse, that have never been profitable, went public. If these kinds of companies are able to go public, it is only because of their market potential.

Some IPOs are successful, but some are not. For example, in 2011, LinkedIn, which was the world’s largest professional network, has doubled its value on the day of its IPO57. The company was then worth US$ 9 billion. On the other hand, in 2012, Facebook lost 20% of its

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value in its three first trading days58. Before its IPO, the company was valued at US$ 104

56

Ulrich Hege (2001), “L’Evaluation et le Financement des Start-up Internet”, Revue Economique, Vol. 52, Numéro Hors Série: Economie de l’Internet, p. 291-312. 57 “LinkedIn Doubles its Value on Day 1 of IPO - DotCom Bubble #2?”, ManagementDirect, http://www.managementdirect.com/resources/linkedin-doubles-its-value-on-day-1-of-ipo-dotcom-bubble2/?r=387/, consulted on May 11, 2012. 58 Heidi Moore, “Facebook’s IPO Debacle: Greed, Hubris, Incompetence…”, The Guardian, http://www.guardian.co.uk/commentisfree/cifamerica/2012/may/23/facebook-ipo-debacle-greed-hubrisincompetence/, consulted on May 23, 2012.

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billion. In three days, the valuation of Facebook lost approximately US$ 20 billion. Actually, “pricing an IPO correctly – to predict, in essence, its fair market price – is a delicate art”59.

o Trade Sale

VCs can also sell their equity stake in start-ups to another company in a trade sale. An Internet start-up that succeeds can be directly sold to another company, the purchaser typically being a competitor or a company in search of brand name, technological know-how or existing users. As it has been mentioned earlier, start-ups can also be acquired only for their team. It should be noticed that trade sale is the dominant exit channel for Internet companies. In contradiction with IPO, it is a private transaction. There are thus fewer restrictions.

Although Skype lost US$ 6.9 million in 2010, it was acquired by Microsoft for US$ 8.5 billion in 201160. Experts suggested that the company has been overvalued since it has struggled to turn a profit. But at the time, Skype had over 600 million users, more than one out of twelve people on earth. Microsoft believed that this big market potential was worth the

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several US$ billion they paid.

59

Heidi Moore, “Facebook’s IPO Debacle: Greed, Hubris, Incompetence…”, The Guardian, http://www.guardian.co.uk/commentisfree/cifamerica/2012/may/23/facebook-ipo-debacle-greed-hubrisincompetence/, consulted on May 23, 2012. 60 “Microsoft to Buy Skype for $8.5 Billion”, CNNMoney, http://money.cnn.com/2011/05/10/technology/microsoft_skype/index.htm/, consulted on May 11, 2012.

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o Liquidation

The worst exit is definitely the liquidation of a start-up. However, some VCs require liquidation preferences before investing in a company61. This is to say that if the company fails, VCs will be the first ones to get back part of their investment. 2.3.3. Ownership Dilution Once a VC agrees to provide financing; and therefore, to receive an equity stake in return, it is time to calculate the ownership dilution. Dilution is the effect whereby the ownership percentage of a founder, or a prior investor, is reduced as a result of the issuance of new shares to a new investor. For this reason, the determination of the equity stake given to the VC must include “what the founding team (and their current investors) may be willing to accept in terms of dilution”62. Let’s say, for example, that two Internet entrepreneurs put EUR 30,000 in their start-up. Table 2 shows the company’s balance sheet at this time.

Assets

Liability and Equity

Cash from new equity

€30,000

Original equity

€30,000

Value

€30,000

Value

€30,000

Table 2: Balance Sheet after Seed Round

A few months later, the website is online and a business angel agrees to invest EUR 45,000

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for 30% of the company’s ownership. Table 3 illustrates the balance sheet after this angel round of funding. Notice that the value of the original equity has now been marked up to EUR

61

Tom Taulli, “Putting a Value on your Startup”, Forbes, http://www.forbes.com/sites/tomtaulli/2012/01/03/putting-a-value-on-your-startup/, consulted on March 17, 2012. 62 Carlos Eduardo, “How Does an Early-stage Investor Value a Startup?”, The DrawingBoard, http://thedrawingboard.me/2012/01/18/how-does-an-early-stage-investor-value-a-startup/, consulted on February 20, 2012.

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105,000. Indeed, if 30% of the company equals EUR 45,000, 70% of it equals to EUR 105,000, and the total value is EUR 150,000. The founders’ ownership is diluted to 70% and the business angel gets the difference.

Assets

Liability and Equity

Cash from new equity

€45,000

New equity from angel round

€45,000

Other assets

105,000

Original equity

105,000

Value

€150,000

Value

€150,000

Table 3: Balance Sheet after Angel Round

Then let’s say that the start-up is becoming an established market player, and that a VC invests 250,000 EUR for 25% of its ownership. Table 4 shows the balance sheet after this Series A round of funding. The start-up is now worth EUR 1 million and value of the original equity has been marked up to EUR 525,000. Moreover, it can be noticed that this investment is an upround. While the post-money valuation of the previous round is EUR 150,000, the pre-money valuation of this round is EUR 750,000. Founders’ ownership drops from 70% to 52.5%. This is to say that each entrepreneur is now left with 26.25% of the company. One might argue that the founders lost much of their ownership, but it is obviously more advantageous to hold 26.25% of a company that is worth EUR 1 million than 50% of a company that is worth only EUR 30,000. Notice that the 30% stake of the business angel is also diluted to

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22.5%. The dilution of the ownership will continue as other VCs come in.

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Assets

Liability and Equity

Cash from new equity

€250,000

New equity from Series A round

€250,000

Other assets

750,000

Equity from angel round

225,000

Original equity

525,000

Value

€1,000,000

Value

€1,000,000

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Table 4: Balance Sheet after Series A Round

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3. Dealing with Intangibles Assets Three different sections are part of the following chapter: in the first one, the three main intangible assets of Internet start-ups will be identified; subsequently, a clarification about expenses misclassification will be made, as well as an explanation of two others significant characteristics that are specific to companies with a great amount of intangible assets; and the chapter will end by an analysis of the accounting treatment of these intangible assets.

3.1. Identification In today’s world, intangible assets represent an increasing proportion of the value of a company. This can be demonstrated thanks to some estimation made in 2000, which results showed that more than US$ 1 trillion were invested in intangible assets63. The most interesting observation made was the same intangible assets were capitalized at more than US$ 6 trillion. This clearly demonstrates that, in the new economy, which is to say the Internet industry, companies derive most of their value from intangibles assets such as intellectual capital, brand equity, and website. And this is also the reason that explains Internet companies have to be valued differently from the other conventional valuing conventional companies. 3.1.1. Intellectual Capital Intellectual capital can be described as the set of intangibles assets that encompasses human capital, structural capital, and relational capital. It should be noticed that some refer to the intellectual capital as knowledge assets. Intellectual capital has a double role: first, it supports

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the capabilities, and second, it transforms them into core competencies64.

63

Leonard Nakamura (1999), “Intangibles: What Put the New in the New Economy?”, Federal Reserve Bank of Philadelphia Business Review, July/August, p. 3-16. 64 Sudi Sudarsanam and Bernard Marr (2003), “Valuation of Intellectual Capital and Real Option Models”, Cranfield University, p. 6.

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Human capital, also called human resource, is the “knowledge provided by employees in forms of competence, commitment, motivation and loyalty as well as in form of advice or tips”65. In other words, it is the value that employees bring to the company, which is the most difficult thing to estimate in a business.

One of the most relevant components of the human capital is the employees’ flexibility, which is a key attitude in investments related processes; such as, for instance, expanding or abandoning. In fact, as it has been stated, “such flexibility itself is a source of value since it helps managers avoid decisions that lock into negative value outcomes”66. And finally, human capital is also a source of competitive advantage, since competition is partially based on human capabilities and competencies.

Structural and relational capitals include elements such as patents, trademarks, copyrights, and customer lists. The valuation of these intangibles assets is easier than that of human capital. In fact, for what concerns technological patents, for example, there are many different benchmarks and technical measurements that can me very useful during the valuation. Between the different methods that can be used by experts, some are focused on the phases of development, the testing cycles, and the patent approvals67. Thanks to the facility to evaluate structural capital, this kind of intangible assets can be transferred or sold easily to another company. Technical patents were taken as an example, but the same thing can also be said for

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other assets, such as customer lists. Moreover, as it was true for human capital, structural and

65

Sudi Sudarsanam and Bernard Marr (2003), “Valuation of Intellectual Capital and Real Option Models”, Cranfield University, p. 8. 66 Sudi Sudarsanam and Bernard Marr (2003), “Valuation of Intellectual Capital and Real Option Models”, Cranfield University, p. 5. 67 IPEV Board (2010), “International Private Equity and Venture Capital Valuation Guidelines”, IPEV Board, p. 16.

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relational capitals can bring competitive advantage to the company as well, for example, through differentiation. Furthermore, these capitals can be subject of licensing agreements.

To conclude, it can be affirmed that as it is true for other intangible assets, intellectual capital is relatively complicated to measure. For this reason, it is often extremely difficult to precisely determinate how much an Internet company really worthy. To support this idea, it has been stated that “the traditional valuation tools (…) do not fully capture how intellectual capital contributes to firm value”68. 3.1.2. Brand Equity The value of an Internet company is influenced by its brand equity, which includes both the brand reputation and the brand image. Indeed, “the image that the company offers to the public is one of the aspects that directly impinge on the market’s opinion”69. Brand image plays a role even more important for pure play companies, than it does for bricks-and-clicks companies. Facebook can be taken as an example. In fact, what can be observed is that the valuation of this social network had a huge increase during the recent years, thanks to its socalled cool factor, which promoted the quickly global expansion of the company. One of the main problem that occurs in this kind of valuation concerns customer emotions, such as liking or disliking something, which are unknown values extremely hard to predict with precision in advance and to measure. To overcome this difficulty, marketing and advertising expenditures play a critical role. To be more precise, it is the three R’s method that when applied has a

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remarkably positive impact on online campaign, raising their chance to be successful. Without the necessity to go too much into details, it is nevertheless important to say that this method is

68

Sudi Sudarsanam and Bernard Marr (2003), “Valuation of Intellectual Capital and Real Option Models”, Cranfield University, p. 4. 69 Carmen Lozano and Federico Fuentes (2006), “The Problems of Internet Company Financing: A Methodological Analysis”, International Research Journal of Finance and Economics, Issue 3, p. 92-100.

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based on three elements, which are: reach, relevance, and return on investment70. This vital role of marketing and advertising can be explained by the fact that “Internet business (…) demands speed to market and branding rather than pure technology innovation”71. This means that being known as fast as possible is fundamental and even more relevant than being the best technically.

However, a company should be careful when spending too much money on branding and advertising because otherwise, the cost of acquiring a customer will be higher than the benefits the company will be able to get from him72. Moreover, it is also essential to be realistic and aware that investments in brand equity rarely have immediate and measurable payoffs, most of the time their outcomes are uncertain.

Brand image does not only affect customers, but investors are concerned as well. In fact, it should also be noticed that “the strength or weakness that an Internet company presents with regards to its corporate image, serves as a key element in the investors’ decision whether or not become involved in a business project”73. And this adds relevance at the role that brand equity plays for a business.

To conclude, it can be said that the main issue when valuing a brand is the volatility of its reputation and image. This means that the value of this intangible asset can be damaged

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overnight, because of many different reasons that can hurt a company credibility and reliabil-

70

Google (2007), “Marketing and Advertising Using Google: Targeting your Advertising to the Right Audience”, Google, p. 10. 71 Karen Southwick (2001), The Kingmakers: Venture Capital and the Money Behind the Net, New York, John Wiley & Sons, p. 30. 72 Google (2007), “Marketing and Advertising Using Google: Targeting your Advertising to the Right Audience”, Google, p. 97. 73 Carmen Lozano and Federico Fuentes (2006), “The Problems of Internet Company Financing: A Methodological Analysis”, International Research Journal of Finance and Economics, Issue 3, p. 92-100.

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ity74. For instance, in the Internet space, this can happen if a company does not respect the privacy policy in regards to its users. 3.1.3. Website Valuing a pure play company means valuing a website or an application. And according to the International Financial Reporting Standards (IFRS), “a website developed by an enterprise (…) is an internally generated intangible asset that is subject to the requirements of IAS 38”75. In order to estimate the fair value of a website, many different criteria need to be considered. Firstly, the website’s position on search engines should be examined: the higher the rank position, the better the value of the website. As an example of search engines, it can be thought of Google, which “PageRankTM relies on the link structure of the Web as an indicator of an individual page’s value”76. Others relevant criteria are the Web traffic and the unique visitors. To analyze these two aspects, Google AnalyticsTM is one of useful services that can be used. Another fundamental element that should be taken into examination is the website’s membership, which plays a big role and has an influence on the website valuation. Indeed, VCs take into account “the number of clients or underwriters as reference to value the Internet shares”77. For instance, if Facebook has been valued at US$ 104 billion before its IPO, it is also due to its 900 million members78, which is to say, more than one out of height people on earth. And when it comes to social networks, an interesting observation that can be made is that users tend to share as many information as possible about them79. This collected data is

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74

Aswath Damodaran (2009), “Valuing Companies with Intangible Assets”, New York University, p. 6. Deloitte, “SIC 32 - Intangible Assets - Web Site Costs”, Deloitte, http://www.iasplus.com/en/standards/interpretations/interp76, consulted on May 22, 2012. 76 Google (2007), “Marketing and Advertising Using Google: Targeting your Advertising to the Right Audience”, Google, p. 11. 77 Carmen Lozano and Federico Fuentes (2006), “The Problems of Internet Company Financing: A Methodological Analysis”, International Research Journal of Finance and Economics, Issue 3, p. 92-100. 78 Heidi Moore, “Facebook’s IPO Debacle: Greed, Hubris, Incompetence…”, The Guardian, http://www.guardian.co.uk/commentisfree/cifamerica/2012/may/23/facebook-ipo-debacle-greed-hubrisincompetence/, consulted on May 23, 2012. 79 Jonathan LeBlanc (2011), Programming Social Applications: Building Viral Experiences with OpenSocial, OAuth, OpenID, and Distributed Web Frameworks, Sebastopol, O’Reilly Media, p. 3. 75

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particularly useful and valuable for the social network companies, which make most of their revenues by selling this information to other companies.

3.2. Expenses Misclassification and Other Characteristics Investments in intangible assets, such as R&D, marketing and advertising expenditures, have uncertain outcomes since they not generate immediate payoffs. As a result, accountants consider these investments as costs; and therefore, as operating expenditures (OPEX). Contrariwise, investors view “R&D and advertising outlays as assets rather than expenses”80, which means that in this case, investments in intangible assets are seen as capital expenditures (CAPEX). Moreover, the market also considers these costs as CAPEX81. To sum up, it can be said that VCs do not share the same opinion that accountants, and that they actually have an opposite point of view. After analyzing the two different points of view, it can be observed that considering investments in intangible assets as OPEX leads to a decrease in the company’s earnings. This has a negative consequence on the valuation of the company, which in fact ends up being undervalued. But the contrary is also true. When investments in intangible assets are considered as CAPEX, the company’s earnings increase. As a consequence, the valuation of the company improves as well, and this causes an overvaluation. To conclude, this misclassification of expenses associated with creating intangible assets has a considerable impact on a company’s valuation.

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Sparing use of debt and equity-based compensation are two other characteristics of companies which have a great amount of intangible assets. These two characteristics will be explained later in this chapter.

80

Krishna G. Palepu and others (2007), Business Analysis and Valuation: Text and Cases, IFRS ed., London, Thomson Learning, p. 141. 81 John R. M. Hand (2000), “Profits, Losses and the Non-linear Pricing of Internet Stocks”, University of North Carolina, p. 18.

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3.2.1. R&D Expenses It has been stated that “a customer’s hit decision is determined by the quality of the site”82, and this is the main reason why Internet start-ups have to bid for customers by investing massively in R&D. But the website’s quality is not the only element that matters, patents play an important role too. In fact, as it has been mention before in this book, competition between Internet start-ups often looks like a patent race. And this is another motive that justifies the application of an aggressive R&D strategy made by companies, in order to be able to compete in the Internet space.

“Accounting rules in most countries specifically prohibit the capitalization of research outlays, primarily because it is believed that the benefits associated with such outlays are too uncertain”83. This affirmation agrees with what has been said earlier: accountants treat research costs as OPEX because their outcome is unknown. To be more specific, U.S. Generally Accepted Accounting Principles (GAAP) requires all development costs to be expensed immediately. IFRS shares the U.S. GAAP’s principles too, but at the same time it declares that development expenses can also be capitalized as a finite-life intangible asset, but if and only if two conditions are fulfilled: the item should be technically feasible for use or sale, and it should be reliably measured. This demonstrated that most accountants treat R&D expenses as OPEX84. On this basis, it can be affirmed that a company’s reported earnings represent its earnings after reinvestment in R&D. And as a consequence, companies with

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intangible assets, such as Internet start-ups, report small CAPEX. The main issue with these conventional accounting principles is that they do not capitalize the

82

Thomas Noe and Geoffrey Parker (2005), “Winner Take All: Competition, Strategy, and the Structure of Returns in the Internet Economy”, Journal of Economics & Management Strategy, Vol. 14, Number 1, p. 141164. 83 Krishna G. Palepu and others (2007), Business Analysis and Valuation: Text and Cases, IFRS ed., London, Thomson Learning, p. 141. 84 Aswath Damodaran (2009), “Valuing Companies with Intangible Assets”, New York University, p. 4.

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biggest part of the investments made by companies with intangible assets. As a result of R&D expenses misclassification, the valuation of this kind of companies is meaningless, since it “makes measures like return on equity and capital, widely used to determine the quality of a firm’s investments, unreliable”85. To sum up, it can be concluded that treating R&D expenses as OPEX, as U.S. GAAP and IFRS required, brings to an inaccurate valuation of companies. 3.2.2. Marketing and Advertising Expenses The classification of marketing and advertising expenses faces the same issue already encountered for the R&D expenses. Indeed, it has been stated that “a portion of advertising expenses should be treated as capital expenses, since they are designed to augment brand name value”86. In fact, since marketing and advertising expenses can be associated with building up brand equity, they can be seen as CAPEX.

According to standard accounting approaches, it is possible to capitalize marketing and advertising expenses only when there is sure proof that their benefits increase over time87. Marketing and advertising are known to be fundamental in competitive positioning, and it has been observed that early investments in these tools is preferable, since they result in a decreased need in the future, allowing a company to be more competitive. This is true because investments in intangible assets, such as brand equity, increase expected future profits88. Therefore, marketing and advertising expenses should influence the future value (FV) of a company positively. Moreover, it has also been stated that “standard accounting approaches

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that fail to capture the strategic value of early investments will fail to capture the real econom-

85

Aswath Damodaran (2009), “Valuing Companies with Intangible Assets”, New York University, p. 6. Aswath Damodaran (2009), “Valuing Companies with Intangible Assets”, New York University, p. 13. 87 Aswath Damodaran (2009), “Valuing Companies with Intangible Assets”, New York University, p. 13. 88 Leonard Nakamura (1999), “Intangibles: What Put the New in the New Economy?”, Federal Reserve Bank of Philadelphia Business Review, July/August, p. 3-16. 86

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ic value of Internet firms”89. This signifies that not all methods are reliable when it comes to the valuation of Internet start-ups. 3.2.3. Other Characteristics Sparing use of debt and equity-based compensation are two features that characterize companies with a great amount of intangible assets, as it is the case for Internet companies.

The main issue of an Internet company is the fact that most of its assets are intangibles. For this reason, banks and insurance companies are usually not willing to lend money to finance kind of business. And this is why Internet start-ups need to raise venture capital. Moreover, an interesting observation that has been made is that “it is possible to establish a negative relation between the debt power of Internet companies and the presence of intangibles”90. This means that the larger the percentage of intangible assets compared to the total assets, the lower will be the borrowing capacity. As a consequence, Internet start-ups are able to borrow less money than start-ups in other sectors; and therefore, they end up with lower debt ratios.

It is has been noticed that companies with intangible assets are likely to use equity-based compensation91. In other words, these companies often use stock options to compensate their employees, and this has an impact on both the earnings of a company and its cash flows. The aim of doing that is to align management’s interests with stockholders’ interests, in order to avoid agency conflicts, and at the same time to allow the company to keep its most talented

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employees. Moreover, the employee pool, which is the “percentage of stock set aside for

89

Thomas Noe and Geoffrey Parker (2005), “Winner Take All: Competition, Strategy, and the Structure of Returns in the Internet Economy”, Journal of Economics & Management Strategy, Vol. 14, Number 1, p. 141164. 90 Carmen Lozano and Federico Fuentes (2006), “The Problems of Internet Company Financing: A Methodological Analysis”, International Research Journal of Finance and Economics, Issue 3, p. 92-100. 91 Aswath Damodaran (2009), “Valuing Companies with Intangible Assets”, New York University, p. 2.

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current and future employees”92, must be large enough to attract new talents. The company’s ownership will then be separated between three different owners: the founders, the investors, and the employee pool.

3.3. Accounting Treatment This section is divided into three parts: the first one focuses on the accounting recognition of intangible assets; the second one on the determination of their fair value; and the last one on there the accounting treatment of goodwill. 3.3.1. Recognition As it is already clear from the title, this part of the section focuses on the recognition of intangible assets. Notice that under IFRS, it is the International Accounting Standards (IAS) 38 that covers intangible assets, except goodwill.

In accordance with IAS 38, it can be said that four decisions need to be made when a company acquires or builds up an intangible asset. The first decision regards the costs which have to be included and capitalized. Actually, a company must account all the costs that were needed to acquire the asset. The second decision to be made is the estimation of the duration of the asset’s useful life. But sometimes, this is not possible, because most of intangible assets, such as brand equity, are not considered to have a definable life-span93. This particular kind of assets is known as indefinite life assets. The third decision concerns the estimated value at the

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end of the asset’s useful life; this is to say, the residual value. It must be noticed that useful life and residual value may be very different from original estimates, and if there is a material change of circumstances, impairments must be made. In fact, the residual value of an intangi-

92

Ruthann Quindlen (2001), Confessions of a Venture Capitalist: Inside the High-stakes World of Start-up Financing, New York, Warner Books, p. 201. 93 IASC Foundation Education (2009), “IAS 38 Intangible Assets: Technical Summary”, IASC Foundation Education, p.3.

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ble asset is an estimate, based on other estimates, and is therefore necessarily wrong. Finally, the last decision that a company should make refers to the pattern in which the benefits of the asset are likely to be realized.

Once an intangible asset has been recognized in a company’s financial statements, it has to revalue at least at each financial year end. Indeed, it has been stated that “after initial recognition, an intangible asset shall be carried at a revalued amount, being its fair value”94. This

revaluation issue leads to the next part of the section. 3.3.2. Fair Value Determination Under both U.S. GAAP and IFRS, the fair value of an asset is the price that would be received to sell it at the measurement date. As a general rule, “fair value shall be determined by reference to an active market”95. However, in the absence of an active market, which is often

the case with intangible assets, the fair value has to be estimated in a hypothetical market96. In order to do so, experts have to take many aspects into consideration. Indeed, “fair value should reflect reasonable estimates and assumptions for all significant factors”97. It is therefore extremely difficult to determine the fair value of intangible assets, since unreliable estimates and assumptions result in unreliable valuation. Knowing the fact that most assets of Internet companies are intangibles, it is really complicated to value this kind of company. 3.3.3. Goodwill

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Goodwill is by definition an intangible asset. Actually, “goodwill consists of the excess of cost over the fair value of net assets acquired and certain other intangible assets relating to

94

IASC Foundation Education (2009), “IAS 38 Intangible Assets: Technical Summary”, IASC Foundation Education, p. 3. 95 IASC Foundation Education (2009), “IAS 38 Intangible Assets: Technical Summary”, IASC Foundation Education, p. 3. 96 PricewaterhouseCoopers (2011), “IFRS and US GAAP: Similarities and Differences”, PricewaterhouseCoopers, p. 201. 97 IPEV Board (2010), “International Private Equity and Venture Capital Valuation Guidelines”, IPEV Board, p. 12.

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purchase transactions”98. In other words, goodwill, which can only be recorded when an entire .

business is purchased, is the difference between the price paid for it and its fair value. Under both U.S. GAAP and IFRS, “goodwill includes all amounts that fail the criteria of an identified intangible asset”99. It must also be noticed that goodwill is not amortized but is reviewed for impairment annually. Moreover, any impairment must be recognized in the operating results of the company100.

Goodwill is an important matter in company valuation. In fact, the total value of a company can be calculated by the sum of its assets plus goodwill. As it has been said before, Internet start-ups have only few tangible assets compared to their total assets, and most of their intangible assets are difficult to value. On this basis, Internet start-ups do not worth much financially. However, VCs and established market players, such as Google or Facebook, give great importance to market potential, and are ready to pay a high price for it. Again, goodwill is what a purchaser is willing to pay in addition to the fair value of a company. One should

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therefore not confuse fair value and total value.

98

Krishna G. Palepu and others (2007), Business Analysis and Valuation: Text and Cases, IFRS ed., London, Thomson Learning, p. 82. 99 Michael J. Mard, James R. Hitchner, and Steven D. Hyden (2011), Valuation for Financial Reporting: Fair Value, Business Combinations, Intangible Assets, Goodwill, and Impairment Analysis, 3rd ed., Hoboken, John Wiley & Sons, p. 53. 100 PricewaterhouseCoopers (2011), “IFRS and US GAAP: Similarities and Differences”, PricewaterhouseCoopers, p. 198.

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4. Financial Valuation Methods As it has already been said, “in the absence of an active market (...), the valuer must estimate fair value utilising one or more of the valuation methodologies”101. Moreover, some valuation methods are irrelevant for Internet start-ups, since the vast majority of these companies losses money and does not even plan to break even in a near future. Indeed, it has been stated that “traditional valuation methods generally do not apply to Internet start-ups, which often have no revenues and no profits at the time of their funding rounds”102. Traditional valuation methods, also known as static valuation models, include methods such as book valuation and liquidation valuation.

The book valuation, which is the net worth of a company according to its balance sheet, does not correctly address the complexities of an Internet start-up. In fact, this method results in an accounting value, which is calculated by dividing the total equity by the number of shares. According to the liquidation valuation method, the value of a company is simply what remains after selling all assets and paying all debts. The given value is however only interesting in case of liquidation.

To sum up, it is not possible to value what an Internet start-up is truly worth with static valuation models, since their results are meaningless. The accepted methods to come up with

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a realistic and fair valuation are presented and discussed in the following chapter.

101

IPEV Board (2010), “International Private Equity and Venture Capital Valuation Guidelines”, IPEV Board, p. 11. 102 “How Do I Value my Internet Start-up?”, Inc., http://www.inc.com/articles/2000/09/20360.html/, consulted on December 22, 2011.

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4.1. Discounted Cash Flow Valuation Method The DCF valuation method is a dynamic valuation model which is based on forecasting future cash flows and discounting them back to present. Indeed, according to this method, the fair value of a company is equal to the net present value (NPV), which is the sum of all future cash flows discounted at the weighted-average cost of capital (WACC)103. This is to say that the value of the company is directly tied to the expected revenues and expenses over a specific period of time. Actually, valuing a company with the DCF valuation method is like valuing a large project104. 4.1.1. Forecasting Cash Flows The first step of the DCF valuation method is to forecast future revenues and expenses, which means that the market potential of the company is taken into consideration. In fact, forecasts are based on assumptions and expectations of the future. It must also be noticed that “uncertainty about key variables plays a major role in the valuation of high growth Internet companies”105. In fact, it is really difficult to predict the success of an Internet start-up; and therefore, to make reasonable assumptions on future revenues. As a result, “financial managers (…) typically produce detailed cash flows only up to some horizon date and then estimate the remaining value of the business at the horizon”106.

Once the future revenues and expenses have been forecasted, the company has to calculate the

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free cash flow (FCF), which is the available cash flow that can be distributed to investors.

103

Michael Jurgen Garbade (2011), “Differences in Venture Capital Financing of U.S., UK, German and French Information Technology Start-Ups: A Comparative Empirical Research of the Investment Process on the Venture Capital Firm Level”, Ph.D. dissertation, University of Kassel, p. 89. 104 Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus (2009), Fundamentals of Corporate Finance, 6th ed., New York, McGraw-Hill/Irwin, p. 384. 105 Eduardo S. Schwartz and Mark Moon (2001), “Rational Pricing of Internet Companies Revisited”, Financial Review, Vol. 36, Issue 4, p. 7-26. 106 Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus (2009), Fundamentals of Corporate Finance, 6th ed., New York, McGraw-Hill/Irwin, p. 384.

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Notice that in order to calculate the FCF, valuers need first to compute the operating income and the net operating profit after tax (NOPAT). The basic formulas are as follows: ܴ݁‫ ݏ݁ݑ݊݁ݒ‬െ ‫ ݏ݁ݏ݊݁݌ݔܧ‬ൌ ܱ‫݁݉݋ܿ݊ܫ݃݊݅ݐܽݎ݁݌‬

ܱ‫ ݁݉݋ܿ݊ܫ݃݊݅ݐܽݎ݁݌‬െ ܶܽ‫ ݏ݁ݔ‬ൌ ܱܰܲ‫ܶܣ‬

ܱܰܲ‫ ܶܣ‬൅ ‫ ݊݋݅ݐܽ݅ܿ݁ݎ݌݁ܦ‬െ ‫ ݈ܽݐ݅݌ܽܥ݃݊݅݇ݎ݋ܹ݊݅ݏ݄݁݃݊ܽܥ‬െ ‫ ܺܧܲܣܥ‬ൌ ‫ܨܥܨ‬

The calculation of the FCF enables to perform a break-even analysis. Of course, it is always interesting to determine how many years a company will take to become profitable. It has also been stated that “a business with a long road to profitability will usually be worth less than one with a quick path to profitability”107. However, a negative FCF is not necessarily a bad sign for a start-up, since it might be running a cash deficit because it is growing very quickly, and not because it is unprofitable. In fact, “rapid growth is good news, not bad, as long as the business is earning more than the cost of capital on its investments”108. 4.1.2. Discounting Cash Flows Once the FCF have been forecasted, they still have to be discounted back to present in order for the valuers to take into consideration the time value of money. FCF are usually discounted at the WACC, which is the average required rate of return109. To be more specific, the WACC is the average between the cost of debt (Kd), the cost of preferred (Kp), and the cost of equity

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(Ke). The basic formula is as follows: ܹ‫ ܥܥܣ‬ൌ  ሾΨ‫ ݐܾ݁ܦ݂݋‬ൈ ‫ܭ‬ௗ ሿ ൅  ሺΨ‫ ݀݁ݎݎ݂݁݁ݎ݂ܲ݋‬ൈ ‫ܭ‬௣ ሻ ൅  ሺΨ‫ ݕݐ݅ݑݍܧ݂݋‬ൈ ‫ܭ‬௘ ሻ 107

Asheesh Advani, “How to Value your Startup”, Entrepreneur, http://www.entrepreneur.com/article/72384/, consulted on December 22, 2011. 108 Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus (2009), Fundamentals of Corporate Finance, 6th ed., New York, McGraw-Hill/Irwin, p. 381. 109 Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus (2009), Fundamentals of Corporate Finance, 6th ed., New York, McGraw-Hill/Irwin, p. 383.

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Kd is the after-tax cost of borrowing today. To get to know the Kd is relatively easy, in fact, one just needs to ask the banks the information, or to analyze which rate similar companies had in same situation. A preferred stock is similar to a bond but first, it pays a dividend and not an interest, and second, it has no maturity date. Kp equals the dividend on preferred divided by price of preferred. However, and as it has been said before, most Internet start-ups are unprofitable and pay no dividend. Notice that an investor does not buy the preferred stock of an Internet start-up for the dividend, but for the price increase. Finally, Ke, which is the required rate of return of the shareholders, largely depends from one industry to another and from the stage of development of the company. The dividend discount model, which is usually used to determine the Ke of mature and stable companies, is irrelevant for Internet start-ups. Once again, VCs fund start-ups for their market potential and not for their dividend. To sum up, the WACC of an Internet start-up is very difficult to forecast.

Two indicators are often used to decide whether or not to invest in a project, and as it has been said before, the particularity of the DCF valuation method is to value an entire business as a large project. The analysis of the NPV, which is the present value (PV) of the cash flows discounted at the WACC, is the first of these two indicators. In fact, a project should be accepted if the NPV is equal or superior to zero. On the other hand, a project should be rejected if the NPV is inferior to zero. The second indicator is the internal rate of return (IRR), which is the rate where NPV is equal zero. A project should be accepted if the IRR is

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equal or superior to the WACC, and rejected if not. Notice that NPV and IRR will always give the same acceptance or rejection decision, but they can rank projects differently. Moreover, while NPV assumes reinvestment at the WACC, IRR assumes reinvestment at the IRR.

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4.1.3. Pros and Cons This part of the section discusses the pros and cons of using the DCF valuation method for Internet start-ups. Actually, in contradiction with static valuation models, the DCF valuation method focuses on the future of the company and takes into account the potential of intangible assets. Indeed, “this model can be used to value any type of asset - physical, financial or intangible”110. Moreover, it has been stated that a company can be treated as a large project; and therefore, can be appropriately valued by the DCF valuation method, as long as its debt ratio is expected to remain constant111. In practice, this condition is satisfied by most Internet start-ups since they cannot borrow money from banks or insurance companies, but are only financed with by venture capital.

On the other hand, one of the main issues with the DCF valuation method is the uncertainty and unreliability of the forecasts. In fact, it is almost impossible to correctly predict the revenues and expenses of a start-up since it has no history. Indeed, “for young and start-up firms, the absence of historical data and the dependence on growth assets make estimating future cash flows and risk particularly difficult”112. To say it simply, planning is guessing, and inaccurate assumptions and expectations make the DCF valuation method inappropriate113. Too often it has been noted that entrepreneurs tend to overvalue their start-ups with faulty assumptions, which led to wrong valuations. A deep knowledge of the Internet industry is

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compulsory in order to make reasonable forecasts. Moreover, “future cash flows are also

110

Sudi Sudarsanam and Bernard Marr (2003), “Valuation of Intellectual Capital and Real Option Models”, Cranfield University, p. 15. 111 Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus (2009), Fundamentals of Corporate Finance, 6th ed., New York, McGraw-Hill/Irwin, p. 381. 112 Aswath Damodaran (2010), The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, 2nd ed., Upper Saddle River, FT Press, p. 21. 113 IPEV Board (2010), “International Private Equity and Venture Capital Valuation Guidelines”, IPEV Board, p. 17.

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Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

subject to the impact of competitors’ ability to develop similar options”114. For example, a

market leader, which has unlimited resources, can rapidly launch a new website or application to compete with a start-up.

Another issue with this valuation method is its high sensitivity. In fact, since projections are likely to change as new information become available, the DCF valuation method generates company valuations that are extremely volatile. For instance, adjusting the discount rate either up or down can result in large changes in the NPV. It is therefore recommended to perform a sensitivity analysis on the different parameters. In addition to that, the adjustment of the classification of expenses, whether they are treated as OPEX or CAPEX, might also dramatically alter the valuation of a company.

4.2. Relative Valuation Method It has been stated that “venture capitalists generally value a start-up based on the current climate and recent comparable deals in the venture funding world”115. The method used is called the relative valuation, which allows experts to value a company by comparing it to other similar businesses116. This approach presumes that investors analyze comparables of companies belonging to the same market in order to value the specific company of their interest. In fact, using comparables as a proxy, they are able to deduct a relative valuation. The first step of this method implies the identification of peer companies. Then, the second

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step is to compare their multiples, which can be adjusted to improve the accuracy of the valuation.

114

Sudi Sudarsanam and Bernard Marr (2003), “Valuation of Intellectual Capital and Real Option Models”, Cranfield University, p. 15. 115 “How Do I Value my Internet Start-up?”, Inc., http://www.inc.com/articles/2000/09/20360.html/, consulted on December 22, 2011. 116 Ruben D. Cohen (2005), “The Relative Valuation of an Equity Price Index”, The Best of Wilmott, Vol. 2, p. 99-132.

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4.2.1. Identifying Peer Companies It is commonly said that a company worth what the market is willing to pay for it. Moreover, it is known that when valuing a start-up, “investors will also consider the price other investors have paid for equity in comparable start-ups in similar markets”117. These are the reasons that push VCs to examine recent deals done in the industry sector of the start-up they wish to value. In fact, they will compare what other investors have paid for similar start-ups.

Identifying peer companies is not easy. It has been stated that “the criteria which are used in selecting peer group members are a) market segment b) target customers c) size of a start-up d) growth rate of a start-up e) capital structure f) geographic location”118. A market segment is used to indicate a homogeneous group of customers, which can be, for example, defined by the same age or a similar occupation. The term target customer is more specific, as it refers to the subcategory of the market segment which is the object of all the company’s marketing and advertising operations. The size of a start-up is used for measurement, and to be more precise, it can be said that it mainly depends from the stage of development119. In fact, on a general rule, for the early stages of development, companies show a smaller size, while when it comes to later stages, what can be observed is that companies show a bigger size. The growth rate of a start-up is the expression utilized to talk about the velocity of its development. The term capital structure is used to describe the ownership distribution of a company: how much is owned by the founders, how much by VCs, etc. And finally, the geographic location is

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another fundamental criteria, especially for Internet start-ups. In fact, as it has been illustrated in figure 1, developed countries have proportionally more Internet users than developing 117

“How Do I Value my Internet Start-up?”, Inc., http://www.inc.com/articles/2000/09/20360.html/, consulted on December 22, 2011. 118 Michael Jurgen Garbade (2011), “Differences in Venture Capital Financing of U.S., UK, German and French Information Technology Start-Ups: A Comparative Empirical Research of the Investment Process on the Venture Capital Firm Level”, Ph.D. dissertation, University of Kassel, p. 88. 119 Ruthann Quindlen (2001), Confessions of a Venture Capitalist: Inside the High-stakes World of Start-up Financing, New York, Warner Books, p. 169.

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countries. Moreover, “the availability of capital in any geography will also affect how an investor gauges his own risk/reward ratio when pricing deals”120. For example, a start-up located in the Silicon Valley would more likely find venture capital, and be successful, than a start-up based in a developing country. To sum up, in order to estimate the price of a company according to the relative valuation method, one should start by identifying similar companies, which between other methods, can be done thanks to the six criteria mentioned above. 4.2.2. Comparing Multiples As mentioned before, the relative valuation method is based on the comparison of multiples. And as a general rule, the multiples taken into account are financial ratios such as the price-toearnings ratio121. However, Internet start-ups are not conventional companies and are, by definition, not quoted on a stock exchange. From this reason, if one wants to value an Internet start-up using the relative valuation method, the appropriate multiples that need to be compared and analyzed are not financial, but rather qualitative and Internet specific. To be more precise, “in the valuation of e-Business start-ups, the following metrics could be used: a) enterprise value per user: this multiple is the price paid for each registered user b) enterprise value per visitor: price paid for each visit c) enterprise value per page impression: price paid per page click d) enterprise value per subscriber: price paid per subscriber”122. Table 5 illustrates the model that would be used for the relative valuation of Internet start-ups accord-

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ing to the metrics above.

120

Carlos Eduardo, “Additional Notes on Early-Stage Startup Valuation”, The DrawingBoard, http://thedrawingboard.me/2012/01/28/additional-notes-on-early-stage-startup-valuation/, consulted on February 20, 2012. 121 Aswath Damodaran (2009), “Valuing Companies with Intangible Assets”, New York University, p. 5. 122 Michael Jurgen Garbade (2011), “Differences in Venture Capital Financing of U.S., UK, German and French Information Technology Start-Ups: A Comparative Empirical Research of the Investment Process on the Venture Capital Firm Level”, Ph.D. dissertation, University of Kassel, p. 89.

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Internet Start-up A Internet Start-up B Internet Start-up C

Value per User

Value per Visitor

Value per Page Impression

Value per Subscriber

...

...

...

...

...

...

...

...

...

...

...

...

Table 5: Example of Relative Valuation for Internet Start-ups

Multiples can also be adjusted by applying a weighting coefficient in order to improve the accuracy of the valuation. This can be useful, for instance, when it is not possible to find peer companies, and the valuer has to modify the multiples of other companies to compare with the start-up in question. 4.2.3. Pros and Cons This part of the section examined the pros and cons of the relative valuation method for Internet start-ups. Starting with the advantages, comparables seem to be the closest guide for this kind of companies. In fact, this method is the one that VCs prefer when it comes to the Internet space. Moreover, it has been stated that “comparables, particularly transaction comparables are favored for early stage startups as they are better indicators of what the market is willing to pay”123.

Nevertheless, the valuation method has also a few disadvantages. First, as quickly mentioned

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before, it is most of the time really hard to find peer companies. In fact, no two Internet startups are the same, and more precisely, they can differ on one or more of the criteria which have been identified to select peer group members. Another evident disadvantage of using this method is directly related to the obviously short existence of start-ups. This means that they

123

Carlos Eduardo, “How Does an Early-stage Investor Value a Startup?”, The DrawingBoard, http://thedrawingboard.me/2012/01/18/how-does-an-early-stage-investor-value-a-startup/, consulted on February 20, 2012.

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have a limited history, and because they are not quoted on a stock exchange, they only have a few comparables available, which besides, are also difficult to obtain. To sum up, it can be affirmed that it is not easy to find peer companies and the accurate data about them. Only affirmed VCs which have built important databases over the time can correctly use this valuation method.

4.3. Other Valuation Methods This section focuses on additional methods that can be used to value a start-up: the first methods to be presented are the probabilistic methods; it follows the First Chicago method; and the section ends with the explanation of the ROM. 4.3.1. Probabilistic Methods Probabilistic methods include decisions trees and Monte Carlo simulations. The decision tree analysis technique is used to establish the most favorable alternative to choose when taking decision. Indeed, this method allows analyzing sequential options and their more or less risky consequences, when the decision maker faces uncertainty124. The various alternative outcomes are given as probabilities, and thanks to their comparison one can tell which decision should be made in order to avoid potential failure in the future. This method can be translated in the case of Internet start-ups, which are in an industry characterized by uncertainty, and where a mistake in the decision making can lead to the failure and

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loss of value of the company125.

124

C.P. “Salty” Schumann (2006), “Improving Certainty in Valuations using the Discounted Cash Flow Method”, Valuation Strategies, September/October, p. 4-13. 125 Aswath Damodaran (2010), The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, 2nd ed., Upper Saddle River, FT Press, p. 68.

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Monte Carlo simulations are based on a random selection process, which resultants are probability statistics that allow the valuer to compare different scenarios126. This method implies the repetition of simulations a high number of times, in order to obtain a range of multiple different possibilities to the valuation, some more probable than others. Each stimulation takes into account one or more of the different parameters, such as the expected growth rate, that have an impact on the financial valuation of a company. Analyzing all these diverse scenarios allow experts to “derivate a distribution for the value”127. This distribution can range from the best case to the worst one, with a peak of concentration for the most likely to happen. In fact, with this approach, “we not only estimate an expected value but also get a sense of the range of possible outcomes for value, across good and bad scenarios”128. To conclude, it can be affirmed that Monte Carlo stimulations are useful in nowadays environment, characterized by doubts and ambiguity, especially for what concern Internet start-ups, because it reduces uncertainty129. 4.3.2. First Chicago Method The First Chicago method, also known as scenario analysis, combines elements of the DCF valuation method and the probabilistic methods. This approach, which was created by Bill Sahlman, professor in the Harvard Business School, relies on three different outcome scenarios. The first one is the best scenario that hypothesizes the success of the company. This case implies the compliance with the business plan, which leads to the most optimistic value. The

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second scenario is the survival scenario, which is the most likely to happen. In this case, the

126

C.P. “Salty” Schumann (2006), “Improving Certainty in Valuations using the Discounted Cash Flow Method”, Valuation Strategies, September/October, p. 4-13. 127 Aswath Damodaran (2010), The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, 2nd ed., Upper Saddle River, FT Press, p. 76. 128 Aswath Damodaran (2010), The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, 2nd ed., Upper Saddle River, FT Press, p. 89. 129 C.P. “Salty” Schumann (2006), “Improving Certainty in Valuations using the Discounted Cash Flow Method”, Valuation Strategies, September/October, p. 4-13.

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company does not meet its expectations; nevertheless, it is able to keep its business alive. And the last scenario, which leads to the most pessimistic value, is the failure of the company.

According to the First Chicago method, the valuer has to calculate the PV of the FCF for each of these three different scenarios130. Notice that the FCF should be discounted at the rate of return required by the VC valuing the start-up. Once this has been done, the valuer can firstly compare the PV of the start-up in the three different scenarios. And in a second time, he can calculate the probability-weighted average of the three PV, in order to determinate the most realistic value of the company131.

4.3.3. Real Options Method Another method that can be used to value an Internet start-up is the ROM. This approach examines future growth and investment opportunities in both tangible and intangible assets132. In fact, a company should always consider three different options when it comes to investment decisions133. The first one is the option to expand, the second is the option to abandon, and the last one is the option to delay or wait. It is fundamental that VCs identify these three different options and recognize their impact on the FV of the company. As it has been said before, small investments made in the early stages of a start-up can have important outcomes in the future. Indeed, “large expenditures in the first period produce valuable strategic real

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options in later periods”134.

130

C.P. “Salty” Schumann (2006), “Improving Certainty in Valuations using the Discounted Cash Flow Method”, Valuation Strategies, September/October, p. 4-13. 131 Aswath Damodaran (2010), The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, 2nd ed., Upper Saddle River, FT Press, p. 64. 132 Sudi Sudarsanam and Bernard Marr (2003), “Valuation of Intellectual Capital and Real Option Models”, Cranfield University, p. 19. 133 Aswath Damodaran (2010), The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, 2nd ed., Upper Saddle River, FT Press, p. 115. 134 Thomas Noe and Geoffrey Parker (2005), “Winner Take All: Competition, Strategy, and the Structure of Returns in the Internet Economy”, Journal of Economics & Management Strategy, Vol. 14, Number 1, p. 141164.

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Conclusion This book has the merit of having covered the subject of the valuation of Internet start-ups, in particular after the burst of the dot-com bubble, in its integrity. The objective was to contribute to the development of this field of study by filling some of the existing gaps.

As it has been said, the valuation of an Internet start-up is not an exact science. It does not only depend on the stage of development of the company, but also on five qualitative factors: the team, the business model, the market, the risk, and the exit options. In fact, VCs usually base their valuation on the perceived growth potential of the company.

It has also been observed that an Internet start-up derives most of its value from intangibles assets that are hardly measurable. Moreover, the misclassification of their related expenses in R&D, marketing and advertising has a considerable impact on the valuation of the company.

Another aim of this book was to identify which method is the most reliable to value Internet start-ups. To resume what has been found, it can be said that the two most accepted valuation methods – the DCF valuation method and the relative valuation method – have both pros and cons. Starting with the DCF valuation method, which is based on financial projections, what has been observed is that it can be used to value intangible assets as well as market potential. But on the other hand, forecasts are most of the time uncertain and unreliable. Moreover, this Copyright © 2013. Diplomica Verlag. All rights reserved.

method has a high sensitivity, which means that its results are extremely volatile. For what concerns the relative valuation method, it can be said that it is the best approach to estimate the fair valuation of a company, since it is based on comparables. But at the same time, it is hard to find peer companies and to obtain information about them.

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The different outcomes could be averaged to better estimate the fair valuation, but as it has been said, “the valuations we arrive at for individual businesses reflect the errors and biases we have built into the process. All too often, we find what we want to find rather than the truth”135. In fact, no matter what the results of the different valuation methods are, investing in Internet start-ups remains financially risky.

This book only focuses on the valuation of Internet start-ups, without giving particular attention either to the post-valuation events or to the price at which the company, or some of its shares, have finally been bought. This might be an interesting subject for future research. For instance, it would be extremely useful to compare the results given by the valuation at

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different times, since it will help to improve the valuation methods.

135

Aswath Damodaran (2010), The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, 2nd ed., Upper Saddle River, FT Press, p. 20.

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List of References •

Books

Ante, Spencer E. (2008), Creative Capital: Georges Doriot and the Birth of Venture Capital, Boston, Harvard Business School Publishing.

Brealey, Richard A., Stewart C. Myers, and Alan J. Marcus (2009), Fundamentals of Corporate Finance, 6th ed., New York, McGraw-Hill/Irwin.

Chaffey, Dave (2007), E-Business and E-Commerce Management, 3rd ed., Essex, Pearson Education.

Damodaran, Aswath (2010), The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, 2nd ed., Upper Saddle River, FT Press.

LeBlanc, Jonathan (2011), Programming Social Applications: Building Viral Experiences with OpenSocial, OAuth, OpenID, and Distributed Web Frameworks, Sebastopol, O’Reilly Media.

Mard, Michael J., James R. Hitchner, and Steven D. Hyden (2011), Valuation for Financial Reporting: Fair Value, Business Combinations, Intangible Assets, Goodwill, and Impairment Copyright © 2013. Diplomica Verlag. All rights reserved.

Analysis, 3rd ed., Hoboken, John Wiley & Sons.

Palepu, Krishna G., Paul M. Healy, Victor L. Bernard, and Erik Peek (2007), Business Analysis and Valuation: Text and Cases, IFRS ed., London, Thomson Learning.

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Valuation of Internet Start-ups: An Applied Research on How Venture Capitalists value Internet Start-ups : An Applied Research on How Venture Capitalists value Internet Start-ups,

Porter, Michael (1998), Competitive Strategy: Techniques for Analyzing Industries and Competitors, New York, Free Press.

Quindlen, Ruthann (2001), Confessions of a Venture Capitalist: Inside the High-stakes World of Start-up Financing, New York, Warner Books.

Southwick, Karen (2001), The Kingmakers: Venture Capital and the Money Behind the Net, New York, John Wiley & Sons.

Valdez, Stephen, and Philip Molyneux (2010), An Introduction to Global Financial Markets, 6th ed. New York, Palgrave Macmillan.

•

Journals and Newsstudys o Journal Articles

Lozano, Carmen, and Federico Fuentes (2006), “The Problems of Internet Company Financing: A Methodological Analysis”, International Research Journal of Finance and Economics, Issue 3, p. 92-100.

Noe, Thomas, and Geoffrey Parker (2005), “Winner Take All: Competition, Strategy, and the Structure of Returns in the Internet Economy”, Journal of Economics & Management

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Hand, John R. M. (2000), “Profits, Losses and the Non-linear Pricing of Internet Stocks”, University of North Carolina.

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