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For entrepreneurs looking to raise capital for their Ugandan startup or investors seeking to make an investment in a Ugandan startup, a valuation is normally a key negotiating factor.
How then do you arrive at a valuation for a venture that is pre or slightly posts revenue, with a business model that is not properly defined, has very few assets in a market with limited peers and even more limited data? What is valuable about such a startup and how do you price this.
As the saying goes, “Price is what you pay, while the value is what you get”, it is important that price and value are aligned as much as possible, even for startups.
To arrive at a value, broadly there are three methods of company valuation are commonly applied: an Asset approach; an Income approach; and a Comparables approach. Any other specialist methods of valuation are usually a variation on one of these methods.
The Asset approach focuses on a company’s net asset value (NAV), or the fair-market value of its total assets minus its total liabilities, to determine what it would cost to recreate the business.
The Income approach focuses on the value of a company based on the amount of income or cash flow the company is expected to generate in the future.
While as the Comparables approach focuses on the value of a company based on similar companies recently bought and sold.
Yet applying any of these methods in Sub-Saharan Africa in general and Uganda specifically poses challenges and uncertainty because:
Startups do not possess much in way of assets, they are just building out their assets; any projections of income or cash flow may over or underestimate the business outcomes; with a small and nascent startup ecosystem with limited exits, void of meaningful comparable transactions and with information closely/privately held, comparables are few and far in between; startups are small and illiquid, any valuation would need to take this into account; Startups are evolving and transient not mature and steady going concerns.
How then should one value a startup in Uganda? The methods identified above, while insightful and instructive, would need to be adjusted to take into account the limitations identified for startups.
In addition, the industry in which the startup plays, stage in the lifecycle and the reason for the valuation will also influence the method and approach of valuation used. One cannot overstate the importance of records in helping to support any valuation.
Let’s outline the adjustments needed to reflect the unique characteristics of a startup.
This would involve identifying what it would cost to recreate the startup today to deliver the product or service being provided including hardware requirements, developer time and inputs, payment for subscriptions and licenses, filing for patents.
Having determined these costs, which are the assets, any liabilities or debts owed would need to be deducted from the assets to arrive at a net asset value (NAV) and is usually thought of as a base or floor valuation.
Needless to say, this method does not take into account the potential cash flow that the venture would be able to generate.
Unlike the asset approach, the income approach takes into account potential income or cash flows. For a technology startup, for example, that uses a subscription model or generates income from transactions, income expected per transaction or per subscriber would be projected into the future against growth in transactions or subscribers.
From this is derived the net income or cash flow that would accrue to the startup after costs are deducted. This income or cash flow would need to be projected over say a 3 year period.
Generally, projecting beyond 3-5 years may not be helpful. At year 3, it may be assumed that investors in the company shall be able to sell the business for a given amount, usually a multiple of the money invested, say 3X – 5X.
The net income or cash flows and the final sale value would need to be discounted to today at the desired return for investors that reflects the startup company’s risk and the prevailing economic conditions, to arrive at a value today.
There is a shortage of comparable transactions in the Ugandan startup market, a basis would be to look to similar startups or businesses in other jurisdictions for which transactions are available and note what value parameters (sales, profits, number of customers/users, number of downloads, customer lifetime value, etc.) and what multiples were applied to these parameters to arrive at a value. For example, Facebook paid $4 per user to arrive at $19 billion valuation for WhatsApp.
The valuation arrived at using any of the methods identified above would have to be adjusted upwards (premium) or downwards (discount) to reflect the issues and challenges identified above which can be linked to illiquidity (startups are difficult to sale), size (startups are small), lack of control (depending on the stake one owns) and intangible value (for example patents, brand).
For each of these factors, the valuation identified would have to be adjusted. Typical adjustments may be for size (say 10% – 15% discount);
- Illiquidity (say 15% – 25% discount).
- Control (say 15% – 25% discount or premium depending on whether the valuation is for a minority stake or majority stake respectively).
- Intangibles (this is very subjective and may be reflected in a premium or discount only implied in the purchase price paid).
Kenneth Legesi is a Management Consultant and Corporate Finance Advisor. He is also passionate about catalyzing financing for startups and SMEs in Africa