In my long finance career, I was involved in numerous ‘transactions’ that involved valuation – not just valuing companies and businesses but also valuing intangibles like Intellectual Property or Wireless Spectrum. The value of assets that I valued varied from single-digit millions to a few billion dollars. And one striking conclusion that I have reached after multitudes of transaction is this – today’s valuation theories are meant to explainvaluationafter the deal is done or at best to define the value boundaries for the deal participants but not to actually arriveat the valuation number at which the deal will be done.
Most of the valuation modern theories such as DCF look at the future earning potential of the business or the asset and arrive at what is called a “present value” using the valuer’s cost of capital or expected returns as the discounting rate. What these valuation models try to do is to mirror the deal-makers’ mind-set in financial terms.
But these theoretical methods have two inherent shortfalls.
They require some big assumptions – regarding long term cost of capital or the hurdle rate at which to discount future earnings to the present value and the long term growth rates … to name a few.
More importantly, these methods present purely one-sided perspective and completely ignore the deal dynamics between the dealing parties, i.e. The seller and the buyer.
These shortcomings have plagued the valuation industry for decades and have pushed the deal makers/ arrangers to depend on generic data-driven dubious market multiples to strike deals! These dubious market multiples, which become circular self-fulfilling prophecies have, in fact, unwittingly led to many market hysteria & crashes fed by unreal frenzies & fears.
Perhaps, emerging game theory could help us come to a better valuation theory that can actually be used to arrive at the valuation by using the dynamics between the “players”. Till such time, the theorist will be religated to the role of being the coroners of the deal industry conducting the value postmortems!
BMW recently increased the size of its venture capital fund, BMW i Ventures, to 500 million euros ($530 million) from 100 million and also decided to move its location to Silicon Valley from New York. Given that the car industry, which was technologically more or less stagnant for several decades, is now buzzing with innovation with AI integration, It is not surprising to see BMW put additional emphasis on exploration.
Large corporations often struggle to keep up with their constantly innovating and evolving Eco-system. That is a result of an inadvertent flaw that creeps in as building regorous internal checks & controls slows down their response time and kills the enthusiasm for innovation.
A few years back, I supported a program in a large cap US-based defense contractor to encourage innovation. I got an opportunity to work with a few of their brightest engineering brains. These engineers were encouraged to leverage some of the company’s cutting edge defense-oriented technology to create innovative “civilian” business models. It was my client’s hope that such an innovation-driven approach can build a hedge against its revenue dependence of Government’s defense budget. Indeed, most of the large corporations sit on idle Intellectual Property assets worth billions of dollars. Encouraging innovation around these IP assets through an internal venture capital program was almost a no-brainer.
There is another reason for large corporations to piggyback on “portfolio” businesses funded through a venture capital fund to explore innovative business ideas. Game theory teaches us that a resourceful leader (like a winner of a 10,000 meters race) does not have to lead from the gate go. Ideally, a market leader can closely follow the “interim leaders” and sprint to catch up and win at an opportune time. Following a venture capital route can help leaders to closely follow the innovative ideas without creating an undue dent to their profitability or reputation in case these innovations fail.
The key question relating to success or failure of any of these program revolves around the culture of the corporate venture capital leaders and their ability to recognize that their risk-averse bureaucracy-driven board room strategies do not work well in innovative ventures’ war rooms!
This article gives a valuable under-the-hood look at typical investor’s “propensity to invest”. 3 key take-aways from this rare inside view are:
99 out of 100 opportunities evaluated are not funded!
More than half of evaluated opportunities and 9 out of10 funded opportunities are ‘in-sourced’ – sourced from within the close network of the investors.
Less than half opportunities evaluated receive a chance to present their pitch in a meeting or a call and less than 2 out of 10 who get a chance to pitch get to the second meeting! So, if a founder of a new venture is meeting an investor for 2nd or 3rd time, she/he has already improved her/his chances of getting funded dramatically! Now, your chances to get an offer have improved from 1 out of 100 to 1 out of 7!
Of course, these are just the stats from one California-based investor. If you are in other less entrepreneurial-friendly parts of the world, the odds above would have to be discounted further. This article also does not state the typical time lag between identification of the opportunity and the ultimate offer. It is often long – sometimes more than a year! Time lag between the opportunity identification and the offer is purposeful since it allows investors to observe if the venture is, in fact, making progress towards the end-goal.