INTERNATIONAL JOURNAL OF BUSINESS, 18(3), 2013 ISSN: 1083-4346

Valuation of Early Stage High-tech

Start-up Companies

Gunter Festela, Martin Wuermseherb, Giacomo Cattaneoc

a
Swiss Federal Institute of Technology Zurich, Switzerland
Festel Capital, Fuerigen, Switzerland
Mettlenstrasse 14, CH-6363 Fuerigen, Switzerland
[email protected]
b
Swiss Federal Institute of Technology Zurich, Switzerland
[email protected]
c
Swiss Federal Institute of Technology Zurich, Switzerland
[email protected]

ABSTRACT

Valuating start-ups, especially at early stages, is a challenge given the lack of historical
data and many uncertain factors about the future. This article presents a methodology
for the valuation of early stage start-ups that we have proven in practice. The risk linked
to a start-up is expressed through an individual beta coefficient as important component
of the discounting factor within a discounted cash flow (DCF) valuation based on the
data in a business plan. Core of this methodology is the development of an evaluation
framework for the individual adjustment of the beta coefficient that is applicable to
early stage start-ups. This was shown by applying the methodology to 16 early stage
start-ups in the fields of biotechnology, nanotechnology, medical technology and clean
technology, which provided an easy-to-handle and comprehensible comparison of
different investment options for early stage investors.

JEL Classifications: G32, M13

Keywords: business valuation; discounted cash flow method; capitalisation rate;

beta coefficient; venture capital; business angels
INTERNATIONAL JOURNAL OF BUSINESS, 18(3), 2013 217

I. INTRODUCTION

The valuation of a start-up is a central matter to both investors and founders (Cumming
and Dai, 2011; Hsu, 2004; Engel and Keilbach, 2007; Hochberg et al., 2010; Gompers
et al., 2010). Generally, the valuation of a company is more difficult the younger the
company is, given the lack of historical data and uncertainty about many elements that
could influence its development (Peemöller et al., 2001). The absence of sound
forecasted cash flows and growth rate of a company or the determination of the cost of
capital are some of the main criticisms against the discounted cash flow (DCF) method
for early stage start-ups (Achleitner and Nathusius, 2004; Moyen et al., 1996; Vinturela
and Erickson, 2004). An easy method of evaluation from the investor perspective,
which is both easy-to-handle and accepted among practitioners, is necessary to better
manage negotiations between investors and founders (Achleitner and Nathusius, 2003;
Armstrong et al., 2006; Paul et al., 2007).
This article presents a methodology for the valuation of early stage high-tech
start-ups based on the information of a business plan and additional discussions with
the founders or the management team. Starting with the future cash flows from the
business plan of a start-up, a DCF valuation gives the company value. The new aspect
is that the beta coefficient as important component of the discount factor, which is one
of the most significant parameters within the DCF valuation, is discussed and adjusted
according to the capital asset pricing model (CAPM). The focus on the beta coefficient
representing the individual risks of start-ups and its individual adjustment can provide
an important simplification in assessing investment possibilities. The methodology was
applied and validated for 16 start-ups in Germany and Switzerland.

II. THEORETICAL BACKGROUD

A. Early Stage Investments

Madill et al. (2005), following the findings of Harrison and Mason (1992), identified
aspects that differentiate business angels (BA) as early stage investors from other
investors. The magnitude of their investments is smaller and earlier in time, when the
so-called “equity gap” is most significant. As a comparison, venture capitalists (VCs)
invest only 1% of the value of their investments in the seed stage (5% of the deals),
18% in the start-up stage and the rest is provided to expand the company (Meyer,
2006). According to Sohl (2007), BAs do not only look for more opportunities but also
invest 16 times as often as typical VCs do. Of other opinion are Mason and Harrison
(1994), who showed that generally BAs invest in fewer deals than VCs. In contrast to
VCs, who look for investments which may produce higher returns, BAs do not have the
monetary capacity to diversify their investments, so instead adopt a less risky strategy,
which leads to fewer “home runs” but also to fewer deals with a complete loss
(Benjamin and Margulis, 1996). Mason and Harrison (2002b) discovered that compared
to VCs, BAs have a fewer proportion of investments in which they lose money, but in
turn a significantly higher proportion of their investments either break-even or generate
only modest returns.
BAs help to bridge the financial gap in the high-risk early stage phase, in that,
having been financed by BAs the credibility of the company raises in the eyes of
218 Festel, Wuermseher, Cattaneo

potential partners and increases the chances of the company receiving further
investment, so they (Maunula, 2006). In doing so, they complement larger VC
companies, especially with regard to the size of the investment, the value added in the
investment phases and the flow of deals (Madill, et al., 2005). Mason and Harrison
(2002a) have noticed that BAs are, in general, looking for more investment
opportunities, mainly because most of the proposals they receive do not coincide with
their investment criteria. For example, in the industry and technology sector, the
company stage or the location may not fulfil their conditions. Many investors do not
possess the necessary technical knowledge required for investing in high-tech areas:
BAs as well as VCs choose to invest in specific sectors where they have acquired
technological and market knowledge, previous experience and a strong network
(Mason, 2006; Murray, 1999; Van Osnabrugge and Robinson, 2000). Finding a good
opportunity takes much effort and results in high search costs, because of a lack of
access to academic researchers and a long selection process (Mason and Harrison,
1992; Mason and Harrison, 1995). How investors base their decisions on different
frameworks is deeply investigated by many scholars (Fried and Hisrich, 1994; Mason
and Harrison, 1996a; Paul, et al., 2004; Zheng, et al., 2010; Van Osnabrugge, 2000).
Besides aspects like financial risks or the business-plan of the company, the involved
VCs in turn have a considerable influence on the attraction of further external funds in
later stages. As outlined in an empirical study by Chang (2004), the better the
reputations of participating VCs and other strategic partners of the start-up were, the
more money it could raise. In their analysis of Initial Public Offerings (IPOs),
Megginson and Weiss (1991) found that the reputation of an experienced VC may
communicate unobserved qualities about the company to the capital market, which
leads to an increase of the market value of the company.

B. Valuation of Early Stage Start-ups

Accordingly to Elnathan et al. (2010), there is a general scarcity in research about

experts’ valuations of private companies. More specifically, there is an insufficiency
not only in the research about the determinants of valuations in private equity
(Cumming and Dai, 2011), but also especially about BAs and their investment
decisions (Paul et al., 2007). Some scholars have addressed some issues, from general
considerations to the identification of the factors that investors consider when
evaluating a company.
The first issue addressed is how start-up evaluations might not depend on start-
up characteristics only, but also on those of the investors. Gompers and Lerner (2000)
show that market conditions impact VC valuations with regard to the value of the
closed VC deals. Specifically, they assume that under perfect market conditions inflows
of money into VCs funds should not be related to a change in the valuation of private
companies. It is shown, that high inflows lower the standards of a valuation and rises
dramatically when the inflows cease. Hochberg et al. (2010) explain how the density of
the VC market and the level of networking affect valuations of newly founded
companies. Cumming and Dai (2011) present empirical evidence on how VCs'
reputation, size, and limited attention impact their bargaining power and consequently
valuations in addition to venture quality and market conditions.
INTERNATIONAL JOURNAL OF BUSINESS, 18(3), 2013 219

The second issue addressed is information asymmetry, which becomes critical

when investors try to evaluate companies based on the information they are provided by
the founders or able to collect (Binks et al., 1992). Sanders and Boivie (2004) explain
how information asymmetry can lead to opportunistic behaviour in form of adverse
selection (i.e. hidden information) and moral hazard (i.e., hidden actions). For this
reason, investors struggle to get valuable and reliable information. To reduce such an
uncertainty, investors should rely on a set of observable indicators, such as corporate
governance mechanisms, even though it might only be feasible when the company has
enough history. Zheng et al. (2010) focus on two kinds of information that influence
investor evaluations: internally generated information on the start-up’s innovative
capability and externally verifiable information on the start-up’s inter-company
network attributes. The study is based on the idea that company capabilities are
heterogeneous among the market participants and hence lead to different company
performance (Teece et al., 1997; Cockburn et al., 2000).
The third issue addressed is how the evaluation process develops. Maxwell et al.
(2011) argue that investment decisions are made according to two stages, a first
selection stage or screening in which investors determine, if the company will be
further considered or rejected, and a second in which a more thorough evaluation and a
negotiation will lead to a potential deal between investor and entrepreneur. Mason and
Harrison (2002) emphasize that focusing on such a process of selection can lead to
higher chances of a successful investment. Other studies have identified more stages in
the process, e.g., a three-stage model by Amatucci and Sohl (2004) and more
comprehensive approaches with eight stages by Van Osnabrugge and Robinson (2000)
and Haines et al. (2003).
The fourth issue concerns which characteristics of a start-up the investors take
into consideration when evaluating. Generally, both BAs and VCs agree that the
entrepreneur itself and the management team are the two factors that mostly influence
their involvement in a financing deal (MacMillan et al., 1987; Van Osnabrugge and
Robinson, 2000; Van Osnabrugge, 2000). A good resume of VCs investment
determinants was done by Hsu (2007), who finds that various characteristics of
founders are important determinants in VC evaluations: prior experience in founding,
both human capital (e.g., training and prior professional experience) and social capital
(e.g., social skills and charisma) of the start-up’s founders are all positively correlated
with higher evaluations. Consistent with this is that the higher the similarity between
the profile of a VC and the profile of a start-up team in terms of their educational
background and professional experience, the more favourable the evaluation by the
venture capitalist will be (Franke et al., 2006).

C. Valuation Criteria

Few studies have, however, been done on the difference between VCs and BAs in
respect of their evaluation of qualitative aspects. BAs perform less professional due
diligence than VCs, invest more opportunistically, rely more on instincts and do not
calculate internal rates of return (Van Osnabrugge and Robinson, 2000; Sudek, 2006).
Sudek (2006) also argues that most of the literature up to 2006 was concerned with VCs
evaluations, while specific research on BAs investment evaluations is rare.
Nonetheless, some scholars have tried to list a series of factors that BAs seem to
220 Festel, Wuermseher, Cattaneo

consider when evaluating a start-up. Feeney et al. (1999) focused on the decision stage
of investments and determined that the criteria on which the assessment of the company
is mostly based are entrepreneur’s abilities and track record. Mason and Harrison
(1996b) agreed with that and also added the fact of how marketing strategy and
financial projection were of core importance.
Van Osnabrugge and Robinson (2000) ranked the 27 most significant criteria for
European angels, where enthusiasm of the entrepreneur and his trustworthiness were
found to be ranked first and second, and sales potential of the product and expertise of
the entrepreneur third and fourth. Sudek (2006) did a comparable study on U.S. angels
with different results. Trustworthiness came first, management team second,
enthusiasm third and potential exit routes fourth. When only considering the criterion
management team, its passion and perceived sense of survivability were ranked first
and second, coachability third and last were the experience of the advisor and the team.
Maxwell et al. (2011) expose an overview of previous research on investment criteria
without rankings, which we summarise as follows: Mason and Stark (2004) identified
the importance of financial numbers and other straightforward, verifiable factors, such
as sales, evidence of marketplace and size as well as patent protection. Skills,
experience, track record, personality of the entrepreneur and of the management team
are factors of human capital that are emphasised by various authors (Sørensen, 2007;
Haines et al., 2003; Mason and Stark, 2004; Zhang, 2011). Feeney et al. (1999) also add
more subjective personality characteristics, like honesty and integrity.
The opinion of Maxwell et al. (2011) that such a long list of criteria might
confuse researchers, investors and entrepreneurs can easily find support. Landström
(1998) suggests the possibility that investors vary their decision making criteria as the
process unfolds over time. Maxwell et al. (2011) build on that and express concerns,
supported by previous literature, that such criteria might be biased while the investor is
trying to recollect the procedure used when evaluating a company. They also argue that
opposed to this list of characteristics, behavioural decision research has clearly shown
how investors in practice often tend to use cognitive shortcuts known as heuristics,
which lead to the use of a smaller number of criteria to evaluate the company only in
the case when they present values above or below a determined threshold. For such a
reason, Maxwell et al. (2011) provide a list of specific criteria based on previous
research that is also suited as an elimination-by-aspects heuristic which investors can
follow to easily reject the majority of opportunities: adoption, product status,
protectability, customer engagement, route to market, market potential, relevant
experience and financial model.

D. Valuation Methods

Besides qualitative considerations, investors often rely on more quantitative methods to

achieve a clearer comparison among investment opportunities. ern nde (2007)
divides evaluation methods into six different groups: balance sheet, income statement,
mixed (goodwill), cash flow discounting, value creation and options. Engel (2003)
structures the same evaluation methods into two main groups. The first group includes
classical methods, which can be applied independently from the objectives of the
evaluation, while the second is better suited for specific conditions related to VC
financing. Achleitner and Nathusius (2003) further subdivide these two main groups:
INTERNATIONAL JOURNAL OF BUSINESS, 18(3), 2013 221

the first subcategory of the classical methods includes fundamental analytical and
market oriented methods. Fundamental analytical methods, based on data of a single
company, can be further divided into single and comprehensive evaluation methods.
Single evaluation methods sum up in a single number the various assets a company
presently owns. When looking at the comprehensive evaluation methods, we have the
widely diffused DCF method, the income method and the real option method
(Ballwieser, 2001; Leuner, 1998; Festel et al., 2009). The second subcategory of the
classical methods considers market oriented methods that compare factors among
similar companies in a determined peer group, like, e.g., the initial public offering
(IPO) or the recent acquisition methods. The second main group concerns the situation
specific methods, which are subdivided into two approaches: first, rules of thumb,
mostly favoured by BAs but only suited as a complement to other methods, and second,
comprehensive evaluation methods, like the VC method and the first Chicago method
(Engel, 2003; Amis et al., 2003; Amis and Stevenson, 2001).
Although some criticism has been raised throughout the years (Moyen et al.,
1996), many have identified the DCF method as the most dominant in practice
(Jennergren, 2008; Jiménez and Pascual, 2008), and according to Vinturella and
Erickson (2004) and ern nde (2007) it is also the most conceptually correct. The
DCF method is based on the idea that the present value of a company is given by the
capacity of generating positive future cash flows (Achleitner and Nathusius, 2003;
Fernandez, 2002). A common feature of this class of methods is the discount of the
future cash flows by the required rate of return, which expresses the risk related to such
payments. The discount rate has to reflect, in the most realistic way, the costs of capital
of the company. DCF methods can be subdivided into more specific methods. If the
balance sheet shows equity and debt, the adjusted present value (APV) method, the
weighted average cost of capital (WACC) method and the total cash flow (TCF)
method are relevant. The term “equity methods” is applied, if only equity is used as
reference capital. ern nde (2004a) furthermore subdivides the DCF methods into ten
different approaches, which differ in the chosen type of cash flows or in the appropriate
discount rate. There are different opinions regarding the time horizon to be considered
in the DCF methods. Vinturella and Erickson (2004) and Jennergren (2008) provide a
model based on the assumption that a company evaluation using a DCF method should
not stop at the first period of 10-15 years, in which the free cash flow is derived from
operations of the company, but also a post-horizon period, which provides a continuing
value of the company under the assumption that it grows at constant and sustainable
rate after the first explicit forecasted period.

E. Discount Factor

It is important to note that usually high tech start-ups are completely financed through
equity, which means that the cost of capital equals the cost of equity. The value of the
forecasted cash flows has to be discounted by a discount factor to obtain the present
value. The discount factor expresses the required return of the employed equity by the
investor and at the same time reflects the costs of capital for the start-up. The literature
contemplates different methods related to the capital market, from the arbitrage pricing
theory to the regression model, in which a risk premium is calculated.
222 Festel, Wuermseher, Cattaneo

In the CAPM, individual systematic risk related to a company is expressed

through a so-called beta coefficient, a measure of risk relative to a peer group
(Vinturella and Erickson, 2004). The beta coefficient has a significant impact on the
capital costs, as the CAPM equation shows ( ern nde , 2004b; Ai and Brockett, 2008;
Womack and Zhang, 2003):
E(R i )  R f  i [E(R m )  R f ]
where: E(Ri) is the expected return on the capital for asset i, Rf is the risk-free interest
rate that is usually derived from the yield of high-quality government bonds, E(Rm) is
the expected return of the market, [E(Rm)-Rf] is the expected market risk premium, and
 i is the sensitivity of the expected excess returns from asset i to the expected excess
market returns, or also
Cov(R i , R m )
i 
 2 (R m )
with Cov(Ri,Rm)) as the covariance between the return of the market and the return of
the asset i, and  2 (R m ) as the variance of the return of the market.
In these definitions it is important to note, that one underlying assumption of the
CAPM is that the required market risk premium is equal to the expected market risk
premium ( ern nde , 2004b).
A beta could be derived from either accounting history or a sensibility analysis
based on the forecasted cash flows. ern nde (2004a) proposes, for example, different
kinds of betas based on financial factors (leveraged, asset, etc.). Start-ups usually lack
such an accounting history and the estimation of variability in future market earnings
might also become problematic, making these propositions hard to translate in practice.
Especially for the valuation of small companies, the CAPM model of Sharpe
(1964) and Lintner (1965) leads to an abnormal description of the expected returns
(Banz, 1981). Based on the CAPM model, Fama and French (1992) developed an
extended model that specifically addresses the risks related to the size and value. In
consequence, they included a “si e premium” to compensate investments in companies
with a relatively small market capitalisation and a “value premium” to encounter the
risk related to high book-to-market values (Fama and French, 2012; Womack and
Zhang, 2003). In contrast to the expansion by adding size and value parameters to the
CAPM, the valuation approach introduced in this article is based on the basic form of
CAPM and the specific risks of the start-up is taken into account by an adjusted beta
factor. In practice, when investors conduct a company valuation they seldom use these
models: only a quarter of VCs utilise the CAPM to determine the risk premium
(Achleitner, et al., 2004). To determine the final discount factor, investors often use
deduction values according to their return expectations and perceived risk (Sahlman
and Scherlis, 1987).

III. VALUATION METHODOLOGY

A. Definition and Adjustment of the Basic Beta Coefficient

INTERNATIONAL JOURNAL OF BUSINESS, 18(3), 2013 223

Important parameters are the risk-free rate and the market risk premium, which are
needed to determine the capital costs or the discount rate, respectively, to be used in the
CAPM. To determine the risk-free rate we chose the rates of government bonds and
treasury securities before the financial market crisis started: a ten-year German
Government Bond yielded a return of 4.126% as per September 1st, 2008 (Bloomberg,
2013). For the market risk premium 5.5% was chosen ( ern nde et al., 2013). The
company tax rate of 35% based on earnings before interest and taxes (EBIT) was given
by the German Institute of Certified Public Accountants (Institut der Wirtschaftsprüfer,
2002).
As discussed earlier, the beta coefficient for early stage start-ups cannot be
derived from past values or by comparison with companies of a peer group. The rate of
return expected by investors in early stage investments and the average capitalisation
rate is 39.5% (Achleitner et al., 2004). Using the CAPM to calculate the cost of equity
for start-up companies in early stages based on a risk-free interest rate of 4.126% and a
market risk premium of 5.5% yields a basic beta coefficient of 6.4 to cover the required
return on equity for VC companies. The calculated basic beta coefficient is suitable for
high-tech start-ups, for example in the biotech, nanotech or clean-tech areas with high
technology and market risk. For start-ups with a lower business risk, such as in the
services or trade sector, a lower basic beta coefficient is justified. For comparison,
public companies in a mature stage usually have a beta between 0.5 and 2.
This general basic beta coefficient of 6.4 for early stage high-tech start-ups has
to be adjusted for each individual start-up based on the risk profile. We developed a
standardised assessment scheme for the adjustment of the beta coefficient. The
assessment scheme is used for the standardised determination of a premium or a
discount to the beta coefficient depending on the risk profile, associated with the start-
up, based on information from the business plan and additional discussions with the
founders or the management team. It contains all the relevant categories such as
technology, products, implementation, organisation and financial aspects and can be
easily applied by an experienced investor after the reading of a typical business plan.
B. Application and Validation of the Methodology
The evaluation methodology was applied to 16 start-ups whose complete business plans
were available (Figure 1). Start-ups were chosen from areas with similar risk profiles,
such as biotechnology, cleantech and nanotechnology (Table 1). Only companies with a
limited range of initial corporate values were considered: such values stated in the
business plans span between 1.2 and 4.1 million Euros.
We developed a simple Excel model in the form of a basic DCF calculation with
which the adjusted corporate values can be calculated. For this purpose the relevant
figures from the business plans, such as revenue projections and costs, are transferred
into the model and the final corporate value can be calculated using the adjusted beta
coefficient. As shown in Table 2, the adjustment of the beta coefficient is based on
various categories, considering technological, organisational, financial and other
characteristics each with related subcategories. Depending on its specific influence on
the risk, each subcategory can lead to a positive or negative impact on the
compensation that a potential investor requires and hence a corresponding adjustment
of the beta coefficient is necessary. These beta adjustments are then cumulated and
result in a beta coefficient for the specific start-up. By using the CAPM, the derived
224 Festel, Wuermseher, Cattaneo

beta coefficient is then applied for the start-up being valued to estimate the required
return, which, in turn, is a decisive input parameter for the company valuation using a
DCF approach.

Figure 1
Steps for the application and validation of the technology after the development

Table 1
Results of the evaluation of the selected start-ups*
Initial Adjusted
Adjustment Adjusted
company Adjusted company
Nr. Sector Country of the beta beta
value discount rate value
coefficient coefficient
[mn Euro] [mn Euro]
1 Biotech Switzerland 1.3 3.0 9.6 0.55 0.6
2 Biotech Germany 1.3 7.5 14.1 0.79 0.2
3 Biotech Germany 1.8 -3.5 3.1 0.21 7.6
4 Cleantech Switzerland 2.1 -1.0 5.6 0.34 3.2
5 Cleantech Germany 2.3 -2.5 4.1 0.26 5.9
6 Nanotech Germany 2.4 3.0 9.6 0.55 1.0
7 Biotech Germany 2.5 4.5 11.1 0.63 0.7
8 Biotech Germany 2.5 -0.5 6.1 0.36 2.9
9 Medtech Germany 2.6 5.5 12.1 0.68 0.6
10 Cleantech Germany 2.9 -4.0 2.6 0.18 16.5
11 Cleantech Germany 3.1 3.5 10.1 0.58 1.0
12 Nanotech Germany 3.2 3.0 9.6 0.55 1.4
13 Cleantech Germany 3.2 2.5 9.1 0.52 1.5
14 Biotech Germany 3.3 -0.5 6.1 0.36 3.7
15 Biotech Germany 3.5 -1.0 5.6 0.34 4.8
16 Biotech Switzerland 4.5 2.5 9.1 0.52 2.0
*
The initial company value is always calculated with the basic beta coefficient 6.6.
INTERNATIONAL JOURNAL OF BUSINESS, 18(3), 2013 225

Table 2
Assessment scheme of one of the start-ups to adjust the basic beta coefficient
Adjustment of the beta coefficient
Category Subcategory Result
+1 +0,5 0 -0.5 -1
Technology still Technology
Technology Technology Technology
Maturity of in initial successful in
successful on a successful in successful in 0.5
technology experimental technical
laboratory scale pilot plant demo plant
phase application
Advantages Costs and Significant costs
Advantages not Costs or quality
compared to No advantages quality and quality
clearly advantages -0.5
Technology competitive identified advantages advantages
identifiable identifiable
technologies identifiable identifiable
Reputation of Moderate Very good
No reputation Poor reputation Good reputation 1.0
scientist reputation reputation
Basic patent Extensive
No patent First patent Basic patent
Patent protection close to being portfolio of 0.5
application application filed granted
granted granted patents

Product benefits Product benefits Product benefits Product benefits

Product benefits
Product benefits not clearly clearly confirmed by confirmed by 0.5
not identifiable
identifiable identifiable first clients numerous clients

Unique selling Unique selling Unique selling Unique selling

Unique selling
Unique selling proposition not proposition proposition proposition
proposition not 0.5
Products proposition clearly clearly confirmed by confirmed by
identifiable
identifiable identifiable first clients numerous clients

Very low Moderate Very high

Scalability Low scalability High scalability 0.5
scalability scalability scalability
Potentially
Currently strong Moderate Long-term low
Competition strong Low competition 0.5
competition competition competition
competition
Business plan Business plan Business plan
Business plan Business plan
Business plan with open occasionally frequently 1.0
unjustifiable plausible
questions proven proven
Technical Technical Technical Technical
Technical
Technical development development development development
development 0.5
development plan plan plan difficult to plan likely to be plan very likely
plan justifiable
unjustifiable justify feasible to be feasible
Implementation
Marketing plan Marketing plan Marketing plan
Marketing plan Marketing plan
Marketing plan difficult to likely to be very likely to be 0.0
unjustifiable justifiable
justify feasible feasible
Business Business Business Business
Business
Business development development development development
development 0.0
development plan plan plan difficult to plan likely to be plan very likely
plan justifiable
unjustifiable justify feasible to be feasible
Management
Competences of Management Management Management
Management team is complete
the management team with major team with some team is complete 0.5
team is complete and very
team flaws flaws and competent
competent
Headquarters
Headquarters Headquarters Headquarters
Headquarters Headquarters location has
location location can be location has -0.5
location location is fine many
problematic improved advantages
advantages
Organisation
Moderate level Very high level
Very low level of Low level of High level of
of competences of competences
Competences of competences of competences of competences of
of advisory of advisory 0.0
advisory board advisory board/ advisory board/ advisory board/
board/ board/
consultants consultants consultants
consultants consultants
Process
Process Process not very Process Process very
Process efficiency exceptionally 0.0
inefficient efficient efficient efficient
efficient
Sales plan
Sales plan Sales plan Sales plan Sales plan very
Sales plan difficult to 0.5
unjustifiable justifiable conservative conservative
justify
Costs plan
Costs plan Costs plan Costs plan Costs plan very
Costs plan difficult to 1.0
unjustifiable justifiable conservative conservative
justify
Finances
Fundamentally Risk of low Average Currently high Fundamentally
Profitability 0.0
low profitability profitability profitability profitability high profitability

Financial Financial Financial Financial Financial

resources for resources for resources for resources for resources for
Liquidity plan 1.0
next year are not next year are next 2 years are next 3 years are next 4 years are
secured secured secured secured secured
7.5
226 Festel, Wuermseher, Cattaneo

In Table 2, such an evaluation scheme is exemplified for one of the start-ups and
the adjustments, highlighted in bold, demonstrate the drivers and rationale behind the
determination of the beta coefficient. This specific assessment increased the start-up’s
specific beta coefficient to 7.5 points, mainly because of a lack of international
reputation of the responsible scientist, the unclear and inconsistent business model and
cost planning and the not secured funding for the next year. In addition, the technology
worked, so far, only at laboratory scale, only an initial patent application existed,
product benefits and unique selling points were not clear, there was strong competition,
the management team showed some gaps, and sales planning calculations were difficult
to explain. As for factors to lower the risk and to decrease the beta coefficient, only cost
and quality advantages compared to competitive technologies were identified.
Table 1 shows a compilation of all start-ups rated with the initial company values
calculated based on the basic beta coefficient 6.4 (it is important to note that these
company values were calculated with our Excel model based on the sales and cost date
from the business plans), the increases or reductions of the beta coefficient, the adjusted
beta coefficients and the adjusted company values. We obtained a much more
differentiated picture with the assessment of investment opportunities based on the
adjusted beta coefficients and corporate values. The bandwidth was from 0.2 to 15.2
million Euros compared with the spectrum of corporate values in the business plans of
1.2 to 4.1 million Euros. With its higher discriminatory power, the new range of values
serves an early stage investor as better indication about the company's actual value
compared to the data from the business plan. Above all, it is an objective comparison of
different investment opportunities mainly based on existing business plans. A
comparison with the company values which were shown by the founders in the business
plans was not done, as such company values had not been calculated in most of the
business plans.

IV. CONCLUSION

The discount rate, which corresponds to the capitalisation rate as the required return on
equity reflects the capital costs of start-ups. To determine the capitalisation rate, the
characteristics of young technology companies have to be taken into account. In
investment negotiations, given the great importance of company evaluations for the
negotiations between entrepreneurs and investors, it is advisable to prepare it
thoroughly with accepted valuation methods in which all possible risks are taken into
account. The beta coefficient is of central importance as an expression of the investor
perceived or suspected risks. In negotiations, the founding team shows the risk as low
as possible and therefore wants to propose a low beta and reasonable costs of equity
with regard to the valuation. Our method is applicable to any early stage start-up and
facilitates a better comparison among companies. It can help to bring the negotiations
between entrepreneurs and investors regarding the company value to an objective basis,
avoiding a focus of the discussion on unnecessary details and the loss of a holistic view.
INTERNATIONAL JOURNAL OF BUSINESS, 18(3), 2013 227

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