06/05/2021
How Investors decide Valuation

How Investors Decide Valuation of your business in 6 stages

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In this blog, discusses one of the critical burning problems faced by entrepreneurs, which is “How investors value a business?” , Decide Valuation

explains that the valuation of a company depends on the perspective of the investor.

Beauty lies in the eyes of the Beholder.

 For Example:

• An investor might feel that your business is not so promising and hence, he/she values your business at Rs. 100.
• On the other hand, another investor might feel that your business is very promising and hence, he/she values your business at Rs. 200.

There is no specific set of rules for valuing a company. However, we derive some understanding regarding the valuation from the market.

#1 Life cycle of a Company

1.Startup stage: This is just an idea stage, where the founder or business owner has identified a problem and has developed a product to solve that problem.

For example:

• Stand and pee device tor women, which was designed to solve the problem that women face while urinating in public places.

• At the intial stage, this device was just an idea; however it has become very popular now.

The product at the startup stage isknown as minimum viable product.

At this stage:

• No gross or net profit
• Risk is high
• Chances of failure of the company are high
• Competitor might enter and disrupt the industry
• Market refuses to accept your product

Since nothing is predictable at this stage, the investors who invest at this stage are looking for high returns and hence, they will squeeze your valuation.

For Example:

At the initial stage, when PayTm was facing challenges in their business, they sold 40% shares of the company for Just Rs. 8 lakhs. However, recently they sold 1% share of the company for Rs.325 Cr.

when the risk and expected return of the investor is high, they provide a low valuation to your company. These kinds of investors are known as Angel investors.


2. Young Growth stage: At this stage:

• Product is accepted by the market and the customers.
• Company starts earning a little revenue
• Company acquires their first 1000 paid customers
• Gross profit of the company starts turning positive. However, the net profit remain negative since the company has to invest in marketing, developing team, technology, systems and processes.

For Example:

Udaan is a B2B e-commerce market place which provides a credit facility to retailers to buy goods from wholesalers.

Udaan can be considered as a young growth company having a valuation of $2.8 Billion due to its huge total addressable market size and a strong team, which includes Ex-Flipkart employees.

3. High Growth Company:

Example: BYJU’S, Big Basket, Reliance Jio

At mis stage:

• Product is accepted in the market.
• Company starts getting the initial revenue.
• Revenue starts increasing year after year.

For example:

i. BYJUS:

2 years back, Byju’s had a revenue of Rs. 500 Cr.

1 year back, it had a revenue of Rs.
1500 Cr and this year, it is expected to
deliver a revenue of Rs.3000 Cr –
Rs.3500 Cr.

Byju’s was a loss-making company till now due to the heavy expenditures on marketing but they are expected to become profitable this year onwards.

 ii. OYO:  OYO increases their revenue 3X-4X every year and hence, they are getting a huge valuation.

Byju’s is valued at $8 Billion and OYO is valued at $10 Billion because they are increasing their revenue ever year and they still have huge total addressable market size.

4. Mature Growth Companies:

Example: Google, Facebook

At this stage:

• Company has been in the industry for a long time.
• Company is growing because of innovation.
• Company starts getting stable income i.e. revenues are stable from old streams and they are building new streams to increase revenue.

Mature growth companies are valued on the basis of P/E (Price to Earnings multiple), which varies in different countries and different situations.

For Example:

If a company is earning a net profit of Rs.100 and its market value is Rs.1000, then its:

Market Value/Annual income = 1000/100 = 10x

Price/Earnings (P/E) = l0x

5. Stable Companies:

Example: Reliance lndustries Ltd., Infosys, TCS

At this stage:

• Company generates stable profits every year.
• Company is valued on the basis of the P/E ratio.
• Company’s P/E varies in a specific range.
• Earnings and price are directly proportional to each other i.e. when earnings increases, the price also increases because P/E stays in a stable range.
• Reliance Industries Ltd, Infosys and TCS have P/E within the range of 20-30 i.e. their valuation varies between 20X-30X of their profits.

High growth companies like Byju’s, are valued on the basis of their speed of revenue, but stable companies like Infosys, are valued on the basis of their speed of profits.


6. Decline Stage:

Example: Jet airways, DHFL.

Reasons for the Decline of a company:

• Companies in the steel and coal industry declined as their business model was dependent upon natural resources.
• Lack of innovation

It is very hard to value the declining companies.

You have to determine where your business lies among the first five stages.

 If you feel that your business has been stable, you need to start innovating; otherwise, a young competitor company might enter and disrupt the market.

For example:

when reliance Industries Ltd. got stable, they launched Reliance Jio and created a new source of revenue.


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