Do Finance terms bother you?

Do you get flummoxed when you hear of Pre and Post Money, Dilution Percentages etc?

Don’t understand the V of Valuation?

I get it and therefore this Common Sense PPT for those who DON’T know and DON’T want to ask 🙂

Please share you feedback… It always helps…!

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Click to download and save:

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First published in January 2014

Smit GanatraGreat read! Simple,easy to understand and no complicated jargons or acronyms!

Alok Rodinhood KejriwalThank you boss

Dhruv MehtaThank you so much Alok for writing and sharing this 🙂

Syed MuksitSimplicity at its best. Being from a non-business background, really had hard times when I first put my hands on learning these basics. You should think of turning all these awesome PPTs in to Coffee table books one day, they will benefit people more than the coffee for sure 🙂

Nakul BhatiaGreat post Alok. Just at the time when I thought about reading an article on this. Simple, time saving, excellent!

Vaibhav SrivastavaGreat Piece Alok.

This is way too easy and inclusive for the amateurs and the professionals, both.

Awaiting you share on the other topics !!!

Harpreet BhatiaNice Presentation and easy to understand…Thanks!!

Aswin NatarajanAh, what I didn’t understand after 4 finance papers in MBA I understood in a ppt!! Thanks a lot sir..

sandeep naredlaEasy and simple to understand, waiting for the next additions.

manoj suryasimple to under stand Alok, thanks for the presentation

Zuhaib KhanEasily explained. Waiting for the next version.

Thanks for sharing.

SahilPerfect! you just made my morning..

Need more simple definitions of funding to understand deep and clear

RishiGood stuff Alok!

Strange coincidence, I actually sat down with a potential hire for 3 hours couple of days ago to explain what equity financing is all about, and what he might be getting into if he signs up for something at any startup. 🙂

I feel a good topic for next deck could be on cap tables; also may be touch upon terms like cliff, vesting, pro-rata, voting rights etc.

Also sent a slightly detailed email as requested.

Parthiban T SDear Alok

Funding explained in simple terms. Awesome work.

Regards

Parthiban

Rajendra JindalExcellent Alok sir:)

Manisha RastogiSimplified finance gyan. Great flow of thoughts.

Haardik JoshiAs usual great !! when one says simplicity in superb ideas & execution, these things/names/brand come to my mind…. Apple (the i-phone maker not the fruit), Sri Sri Ravi Shankar, Maggi Noodles, … Alok Kejriwal….

Keep at it sir!!

HJ

Haardik Joshiplease keep adding to this / or do a follow up write!!

cheers

Vimal DharAlok thanks a ton for this wonderfully simple presentation to the scary financial concepts…Request you to pls incorporate all the other topics regarding funding and help us…I am sounding bit greedy may be not only bit…request you to cover DCF and NPV as well…as these are most prevalent models these days for investing….THANKS A TON Regards Vimal

Muhammed Ayazi always wondered what makes a CEO so so important.

He doesn’t sits in the office for the working hours coding,signing files,making decisions etc etc…

Why he is the man of steel?

well i am very clear now he is not the man of steel he’s BATMAN hunts in the dark !

Rajaram Pittalajust loved it.. !! simply wow.. what an easy explanation.. I have no clue about this funding untill i read this ppt. thank you Alok. and yeah try to add a following write up or another ppt for this 🙂

Amit KumarSir ji, Thank you so much for explaining these terms in so simple way. Wonderful read!! I never thought that these terms will be so easy to understand ever. Thanks a ton! 🙂

Kumar ArayanSimplicity is the ultimate beauty !

RajatNicely explained. Please add the next slides 🙂

Praveen KumarNow I understood what these scary things are 😛

Jitendra GursinghLove it when complicated crap jargon is dissected & made simple for humans to understand. Great going Sir!

Sachin KarpeGreat post. Actually so many factors we need to consider when you explore your funding options. Like are you in need of short-term or long term? The funds is for operating expenses or for capital expenditures. Do you need all the funds now or in small amounts over monthly terms. To star-up a new business need a lot of efforts. Thanks for sharing such a useful article. Keep posting and share your knowledge.

Aashika ChittiappaSo simply explained, thank you!

Roshan AnandSir,

We can’t take the basic rate (or discount rate) of 10% to calculate the valuation of the company. The interest rate of 10% that the bank gives is almost risk free. So, the same should not be applied for any start-up as the risk is very high and the investor would expect the discount rate to be in line with the risk.

Alok Rodinhood KejriwalIn fact, thats why valuations are higher… because the return should be HIGHER than the riskless rate…

Ps – NOT lower because thats a negative co-relation

Roshan AnandOk let me take the same example that you have used to explain this.

Profits/annum = Rs. 75 lacs

Let us assume that the investor wishes to get discount rate of 50% (I have read that normally investors expect discount rate of 30-70% depending on lot of things, so I have taken 50% for our calculation.) You have taken discount rate of Bank at 10%.

Now to get profits of Rs. 75 lacs per annum, one should just invest Rs.1.5 Crore at an interest rate of 50% per annum. So, the valuation of the company at 50% discount rate should be just Rs. 1.5 Crore and not higher than Rs. 7.5 Crore.

Obviously, this is negative co-relation.

Talking in technical terms, this is a case of perpetuity as we are expecting an identical cash flow of Rs. 75 lacs per annum. Then, Present value is calculated as (C/r) where C = per annum cash flow generated and r = expected discount rate

So, the expected present value(Valuation) of the company earning Rs. 75 lacs at 50% discount rate would be Rs. (75/50%) = Rs. 150 lacs or 1.5 Crore.

Refer – http://www.investopedia.com/terms/p/perpetuity.asp

Alok Rodinhood KejriwalYour argument doesn’t make sense.

Because thats the equivalent of a Bank Manager coming to you and saying that while you are getting 10% return on your money, he wants to TAKE your money and offer you a DISCOUNTED rate of return because he is safer etc!

Investors NEGOTIATE valuations.

PS – Discounts on valuations are DOWN ROUNDS (when Businesses are heading downhill) – not improved valuations. This PPT is for potentially successful companies – not the ones that are going downhill. (case – if the 75 lacs in this year will become 50 lacs the next year and 25 lacs the next year…)

Now, to tackle your example:

If profits are 75 lacs and safe interest is 10%, obviously MINIMUM valuation is 7.5 crores of the Company.

Now, as the entrepreneur, you will say my Company is valued at 15-20 crores (because you will obviously Project BETTER CASH FLOW THAN 75 lacs in the years to come) to which the VC will try and negotiate and DISCOUNT (read Negotiate) THE VALUATION you are demanding.

Maybe, the valuation will settle at 10-12 crores.

Hence, he will INVEST money at a pre-money value of 10 crores (or even 7.50 crores if he negotiates hard!!)

What you have done in your example is confused INVESTMENT NEGOTIATION with BUSINESS RISK! (that 50% of cash flow will dry up)

Now, let me point out the point you missed (the INVESTMENT part):

If the present value of the Company as you state is 1.50 crores, how much will the investor INVEST TO GET 50%?

1.50 crores? (1.50 crores pre money + 1.50 crores investment = 3 crores post money. 1.50 crores investment on 3 crores valuation = 50% ownership)

If we go by your example, the company that makes 75 lacs per annum will be now worth 3 crores, with 2 owners each owning 50%

Hence, the VC will be entitles to 37.50 lacs profits (50% of 75 lacs) on an original investment of 1.50 croreso or A RETURN OF 25% (not 50%!!) per annum??

Ask yourself – if you were making 75 lacs per annum, why would you give away half of that = 37.50 lacs for just 1.50 crores?

Does that make sense to you?!

This will explain the confusion about mixing VALUATION WITH DISCOUNTING of CASH flow..

Roshan AnandYou have got me wrong here. By discounting, I do not mean that the valuation has been discounted. And I am not talking about negotiation which is done by the investors and the owners, neither am I talking about companies which are going downhill.

Discount rate means the rate of return that the investor expects to make from his investment. This number is used to calculate valuation/NPV of the company in DCF method.

I was trying to understand what discount rate normally investors expect from startups. As you said, it looks weird to value the company just for 3 crores when the profit is 75 lacs. I was helping one of my friend make estimates of future cash flow and valuation as he had to present the report to one of the investor. But, I got puzzled when came to know that angel investors expect more than 50% discount rate (Source: Many quora posts, could not find anywhere else).

One of the Quora answers – Check the 2nd answer by Bo Brustkern, see his explanation for discounting.

I think I have confused you a lot.

Sanchita DuttaI always refer to this particular presentation when in doubt and really like the way Pre-Money, Post Money and Dilution is explained. Simplistic but the concept is easily understood…thanks once again

Sanchita (http://www.indiacod.com)

Taruna big big thanks for this post. Now i know V of valuation 🙂

Rohit SardanaI am a new Alok’s and Rodinhood’s fan. Must say, this ppt clears the concept of pre-money and post-money.

Priyesh ChoudharyYou have simplified this awesomely Sir. Would love it if you add more topics to it. Can’t wait!! Thank you so much 🙂

Kiran KumarSimply awesome Alok. More please.

Vivek SrinivasanExcellent read to get people warmed up to the idea of valuation and dilution.

Shilpi MahajanAlok, I am a finance professional and find this so simple to understand!!

Manish Singh BishtYou made it super easy !! Thanks!!

Alok Rodinhood KejriwalAdded the Slideshare link to download and save 🙂

Deeti DaveIt can’t be simpler than this, Thank you Alok for sharing this!

the VC referred here is a smart lady 🙂

Anoop NairAwesome.. Never knew that calculating Dilution is that simple. 🙂

SHIVA KUMAR POOSARLAThrough your PPT, I have learnt the following basics today:

a) Valuation

b) Pre-money and

c) Post money

Though I was reading so many articles, no one gave this much clarity. Clarity is strength.

You can do a sequel for this for advanced concepts.

Best wishes

Shiva Kumar.

Ssooraj RauthWOW! Great article. Even school going boy will understand Funding concept. Thanks for sharing

Tarun AgrawalNicely summarized but it is applicable only to specific companies at that stage. More like company which has stable cash flow and overcome from a “Startup” stage.

VvkBuddhbhattiI always thought Valuation in terms of Market Cap i.e. No. of outstanding shares x Price of each share, but never understood its inherent meaning. Now its clear. Thank you Rodinhood. Would like to read on remaining topics as well.