Outreach Networks: First Venture Round - Essay Example

Outreach Networks: First Venture Round Why do Everest Partners require a 30% equity stake in Outreach Networks in exchange for an early-stage investment of $30 million? Show how Everest would justify requiring this stake using the Venture Capital valuation methodology. (25 marks) The ORN’s largest stockholder owns 75% of the company. In the VC firm, the Everest Partners have successful records in the growth of technology companies that invested $30 million mainly to improve the ORN’s capabilities to grow and come up with promising marketing prospects that might have taken longer to prosper. The foundation of every venture capital financing is derived from the communal acceptance and valuation of the company through the investors and entrepreneurs. These valuations replicate both the entrepreneur and the determination to multiply the acceptable amount (Maimbo, 2011). The level of ownership that should be provided in return to the venture capital and expertise of the firm and the ventures that investors were determined to putting their risks should reward the investor. This vibrant concept is usual misunderstood as it comes with disadvantageous consequences. Therefore, considering valuation from the venture investor’s point of view is very essential. In fact, realizing how valuations are determined and adjusted throughout the life of the company is critical. As a result, the relationship between the investor and the entrepreneur becomes the ultimate success of the company. Valuation methodologies come in different stages of investment in relation to the availability of quantitative and qualitative data. However, the main language and concept of the venture capital valuation must be universal, simple, and well understood so that the discussion of valuation about a venture capital investor determines how venture investors are considered constructive and justified in various valuations. During the early-stage companies, there is offer of the perspective and the self-motivated roles of valuation throughout the life of the companies. Basic Mathematics In almost all the private equity deals, people tend to focus mainly on the pre-money valuation that is the estimated value of the company that comes prior to any equity purchase. By determining the pre-money valuation of the company, the amount of capital accepted by the company is combined. This helps in determining the amount of equity ownership that is sold in exchange to the invested capital. Therefore, the resulting valuation after the investment of capital is known as post money valuation. Pre-Money Valuation + Invested Capital = Post-Money Valuation Price per Share = Pre-Money Valuation / Pre-Money Shares This means that, it is not necessary to focus on the valuation negotiation. It is equally important to negotiate for the pre-money valuation as the decision of the entrepreneur and the amount of capital accepted, and the predicated efficiency in the company that use the available capital. Methodology In the early stage infestation, company’s oftenly comprises of little more than an entrepreneur with the weighty idea. Valuations at this seed stage generally propel numerous factors that are subjective to nature. For instance, while evaluating the CEO and the management team new innovations of the value intended results in the evaluation of the intellectual property. In this expected time-to-market, the estimated profitability of the capital needs is in a collective risk in the unpredictability and the principle structure. In the post-seed investment, the transitional data points out events such as demonstrating the principle validation of the resulting products that is strongly the factor considered in the valuation (Maimbo, 2011). The company that matures as a result of the revenue stage as it more quantifiable as data is produced in the operating statistics of performance. The actual results allow investors to provide the accurate model of the quarterly and the annual revenue, EBITDA, and enterprise valuation. This information is well labeled in the table below. Valuation by stages Financing Company Stage Data Risk/Uncertainty Value(MM) Seed Incorporation; early development Soft data; value propositioned Extremely high $1+ Series A Development Validation, time to market Very high $3+ Series B Shipping products Prelim revenue High $7.5+ Series C Shipping Product Predictive revenue Moderate $10+ Later -Stage Shipping Product, Profitable Hard data, EBITDA, net income Lower $20-50+ The above table indicates the guide to the minimum valuation levels that have the valuation trend line of the typical investment as the company grows to maturity. All the risks varies inversely in relation to the quality and quantity of data. The highest degree of uncertainty is inbuilt in the seed and in the early-stage investments that is translated to lower pre-money valuations. The failing rates in the established companies are odd and therefore the investors should be compensated because they place their capital at risk. Additionally, at the late stage the investors have benefit of the predictive financial models that help in mitigating the risks. As such, they end up paying for the reduced risks with higher pre-money valuations (Maimbo, 2011) 2.Is Outreach Networks a typical start-up company seeking Venture Capital funding? Can Perez argue that any of its particular characteristics mean that Everest should get a smaller equity stake than the 30% they are asking for? Justify your answer with numerical analysis. (15 marks) The Outreach Networks sell the wireless networking products that involve products and solutions that are licensed in the higher performance radios, antennas and management tools that target the large population in the world with difficulties towards the internet access. The estimated world’s population that could access the internet in the developing countries. For instance, 35% in Europe,26% South America,31% North America,9% Asia Pacific He proposed that Everest Partners invest $30 million in ORN is in exchange of 30% of the company. The 31% of the company’s revenues came from sales in North America; in future it was growing to the expected market in and outside North America (Maimbo, 2011). In calculating both accumulated taxes on the income and earnings that comes in the delayed tax as well as the specific tax rates. The income tax incurs expenses in the foreign connection that is exempted from taxes. Both the incoming taxes and other related business is the income that amounts to the economic fair market value of the accounts that are receivable. Discount is in the realization and collectability that is relates to the contractual allowances and discounts in the present value that are different in reflecting the time and value of money and opportunity cost. The marketing costs help in claiming resolutions and proper collection of management cycle (Maimbo, 2011). 3.Carry out a Discounted Cash Flow valuation on Outreach Networks that Perez could use to determine the value of the company if it accepts Everest Partners investment. Critically compare the DCF valuation with the VC methodology. What are some of the differences between a target rate under the VC method and a market-adjusted rate, such as that obtained from the Capital Asset Pricing Model (CAPM), used in carrying out a DCF valuation? (30 marks). Discounted Net Cash Flow (DCF) Method The financial statements requires management that helps in making estimates and assumptions that bring effect on the application that account for the policies that register other amounts in the liabilities, income, assets and even expenses. The estimated results in the essential assumptions the evaluated in the constant valuation. The source of the accounted revisions that estimate some of the recognized duration where the estimated values are revised and may affect the future (Maimbo, 2011). Particularly, the significant information about the estimation of uncertainty and other vital judgments that apply in the accounting policies. Additionally, other significant effect is on the recognized value of the financial rates. While determining the fair value of the financial assets and liabilities, there are no observable market prices that require the use of that valuation procedure. Most of the financial instruments in the little price transparency there is fair value that is less objective and required varying degrees in the marketing factors. For instance, in the table below. 2009 2010 2011 2012 2013 2014 2015 2016 2017 Revenue $9.00 $22.00 $63.00 $137.00 $198.00 $260.00 $335.00 $425.00 $525.00 year-on-year growth 144% 186% 117% 45% 31% 29% 27% 24% COGS $4.20 $10.90 $37.20 $82.40 $117.10 $153.40 $194.30 $242.30 $290.00 Gross Profit $4.80 $11.10 $25.80 $54.60 $80.90 $106.60 $140.70 $182.70 $235.00 Operating Expenses $2.79 $4.32 $8.50 $15.76 $20.78 $29.90 $41.85 $57.35 $77.15 EBITDA $2.01 $6.78 $17.30 $38.84 $60.12 $76.70 $98.85 $125.35 $157.85 Depreciation and Amortization $0.05 $0.11 $0.32 $0.69 $0.99 $1.30 $1.68 $2.13 $2.63 EBIT $1.97 $6.67 $16.99 $38.16 $59.13 $75.40 $97.18 $123.23 $155.23 EBIT Margin 21.83% 30.32% 26.96% 27.85% 29.86% 29.00% 29.01% 28.99% 29.57% Interest Expense $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 Profit before Taxes $1.97 $6.67 $16.99 $38.16 $59.13 $75.40 $97.18 $123.23 $155.23 Taxes 30% $0.59 $2.00 $5.10 $11.45 $17.74 $22.62 $29.15 $36.97 $46.57 Net Income $1.38 $4.67 $11.89 $26.71 $41.39 $52.78 $68.02 $86.26 $108.66 Capital Expenditures $1.00 $1.45 $1.90 $2.45 $3.10 $3.38 Increase in Networking Capital $6.00 $8.67 $11.39 $14.67 $18.61 $22.99 Cash flow $20.39 $32.26 $40.80 $52.58 $66.67 $84.46 4. Given the high equity stake that Everest Partners is demanding, should Perez take the VC funding? Estimate the DCF valuation of Outreach if it does not receive the funding from Everest Partners, stating your assumptions. Critically analyse whether accepting the investment from Everest Partners in exchange for 30% of the equity makes sense for Perez and the other shareholders compared to choosing a go it alone approach. (30 marks) The Discounted Cash Flow Model The assumption that the discounted cash flow model bases its purchasing power of assets as the anticipation that collects cash inflows. Therefore, in the discounted cash flow valuation of Outreach Networks, the value of the assets determines the discounting of the future expecting cash flows that the assets are appropriate in discounting rates that reflects the risks involving cash flows. The discounted cash flow model values the entire company by discounting the free cash flows use the weighted and average cost of capital that has the discount rates that then subtracts the value of the 30% equity stake from the value of the company that reaches the value of equity (Maimbo, 2011). Using this model, the value of the company is expressed as the estimated cash flows from the first year to infinity that is discounted as the weighted average cost of capital that is employed in the company. Therefore, the expected free cash flow in the firm is given within a year and is calculated using the formula indicated below: Free cash flow to a firm = After-tax operating income − (Capital expenditures − Depreciation) – Change in non-cash working capital. For each of the mentioned companies, the forecast period that is selected, while consulting the company’s requirement that details cash flow forecasts that are made within that period. Convincingly, the discount rate that was used in the weighted average cost of capital (Maimbo, 2011). In the Outreach Networks: the cost of equity component of the discount rate requires to be calculated using the market model as shown below. Outreach Networks: First Venture Round Comparable Company Valuation Data (dollars in Millions) Company Name(Ticker) Market capitalization Revenues Revenues,1 Year Growth % EBITDA Margin % Total Debt/ Capital % TEV/Forward EBITDA Forward P/E Beta Acme Packet, Inc. (APKT) $2,224 $295 45.6% 30.1% - 13.7x 24.3x 1.50 Aruba Networks, Inc (ARUN) $2,258 $433 48.2% 3.0% - 13.3x 31.5x 1.95 Aviat Networks Inc (AVNW) $108 $463 3.9% 0.2% 7.6% 4.2x 21.3x 1.35 Cisco Systems (CSCO) $100,206 $43,724 4.7% 25.3% 26.3% 6.4x 10.3x 1.20 Mean $26,204 $11,229 25.6% 14.6% 17.0% 9.4x 21.8x 1.50 Median $2,251 $448 25.2% 14.1% 17.0% 9.9x 22.8x 1.43 According to the table above, the valuation multiples in November 2011, all the ten years treasury rates were assumptions as well as the market risk premium. Treasury rates: 5% Market risk premium: 6 % The Company descriptions: The ACME Packet provided Session delivery network solutions should allow proper delivery of voice, data descriptions, Video and Unified communications Services are applications across Internet protocol (IP) Networks. The Aruba Networks, incorporated in 2002, provided the subsequent generational network access solutions in the mobile enterprise. The products that are uniformly wired with wireless network infrastructure in the seamless access solution that corporate with the headquarters, in the mobile business professionals with the presences of the remote workers (Maimbo, 2011). The Aviat Networks were manufactured and designed in the wireless networking products, solutions and other services in North America. The offered digital microwave transmission systems and the long distance trunking applications are in access. There is also provision of broadband wireless access that is based on the stations and customer premises. In CISCO Systems, products are manufactured and designed such that the IP-based networking system is sold. Other products that are directly related to communication and IT industry in the whole world. There are routers that are offered in that they are interconnected to the public and private IP networks for mobile, video applications and data as well as voice switching products that provided connectivity to end users workstations, IP phones, access points, and servers (Maimbo, 2011). While comparing the valuation models, there is a controversial issue that the discounted income method is preferred in the accounting field. Finally, the discounted cash flow method is one of the methods of choice in the finance field. References Maimbo, S. (2011). Financing Africa: Through the Crisis and Beyond World Bank e-Library (Illustrated ed.). World Bank Publications. Read More