If the rise and fall of Powa Technologies taught us anything, it is that fintech valuations are not always rooted in reality. Powa technologies, once estimated to be worth $2,7 billion collapsed earlier this year. What made this sudden fall from grace possible?
In addition to two consecutive funding rounds from Wellington Capital , the deal that tipped the scale was the acquisition of MPayMe for $75m. It was an all-share deal and Powa claimed the merger brought the value of the company up to $2.7 billion after they paid with 3 per cent of its pre-acquisition shares. This basically allowed Powa to set their own value, which was shortly after confirmed by raising an additional funding round from Wellington capital at the same valuation. Then everything changed early 2016, and the following fire sale of the remnants of Powa exposed that the value had been inflated all along. Deflation of fintech valuations also apply to succesful ventures, as Square experienced when they went public last year. Not only was the value lowered, but no everyone got confused in the middle of the hype. The recent 35% plunge in Lending Clubs share price shows that this does not only apply to payment companies, but also represent a reality check for marketplace lending and the alternative finance space.
Now that the desperate hunt for fintech unicorns is starting to cool off, valuations are becoming more focused on underlying values rather than inflated expectations, and a lot of fintech companies share a lot of similarities with tech companies in terms of valuation. Valuating technology companies is hard, but many of the traditional methods are still applicable.
The financial valuation is often where you start, and should not be underestimated. When it comes to fintech, one of the key questions if whether to look at future earnings or assets. This basically boils down to the fundamental business model of the object, but regardless of valuation method, it is all depending on the assumptions. Assess the adressable market from a bottom-up perspective. The “if I could get 1% of every American to subscribe to my services”- approach is rarely of any use. How will this play out in terms of potential revenue streams, assets under management, etc. How capital intesive will it be to grow the business, what is weighted average cost of capital and how wil lthat capital be put to use. These are just some examples of financial consierations, and should only serve as a reference in terms of valuation. Kauffman foundation states that there has not been proven a J-curve for any venture investments since 1997. Despite this, every single business plan I have looked at has promised to deliver a J-curve in terms of cash flow.
In order to verify the numbers, a peer group analysis as a useful method. Compare valuation multiples with similar companies. Just remember that fintech is not one single discipline, and multiples varies according to segment and funding stage. If you do not have a transaction database of your own, there is a lot of great resources online such as Crunchbase.
Another way of reality orienting the valuation is to consider the relationship between the proposed valuation at the time of investment and the potential future value at a given point in time. If you acquire a 10% share of the company for $20 million and expect a 7x return on invested capital after 5 years, is it plausible that the company may be worth $700 million five years later. The financial valuation as well as peer group analysis should work as a good reference for this. Remember to account for additional funding rounds, as the initial investment often leads to additional follow-up investments or dilution of shares if you do not participate in the next series.
A bottom-up approach often serves as a reference point to the alternative cost of creating it all from scratch. This may include, but should not be limited to: Money spent on external services (development, legal, accounting services, etc), the amount of time invested in the company (at a reasonable hourly rate or calculated from salary costs from the expense sheets). Are there any strategic important contracts or integrations? What is the user acquisition cost? Is there any strategic value (often the least tangible part of any valuation) in the object? The latter is often where investors go over board and fail to see that the emperor is in fact not wearing any clothes.
The combination of these may present a reasonable negotiation range, and the weighting should be based on the primary value object in the company, as well as reason to by. If the reason to buy and/or the value object is unclear, it is probably better to stay away.