#+title: Section 9 | Lesson 50 - How to Value Private Companies and Growth Methods
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* Links
- [[./../mba-main.org][TOC | Business]]
- [[https://www.udemy.com/course/an-entire-mba-in-1-courseaward-winning-business-school-prof/learn/lecture/5805330#overview][S09:L50. How To Value Private Companies the Easy Way & Growth Methods]]

- tables: [[file:../_data/market share spreadsheet.numbers][Market Share Spreadsheet.numbers]]

* Notes

** Financial Table
| Year                              | 2015      | 2016       | 2017        | 2018        |
|-----------------------------------+-----------+------------+-------------+-------------|
| Revenue                           | 2,000,000 | 20,000,000 | 350,000,000 | 661,500,000 |
| COGS (Cost of Goods Sold)         | 1,800,000 | 16,000,000 | 175,000,000 | 264,600,000 |
| Gross Profit                      | 200,000   | 4,000,000  | 175,000,000 | 396,900,000 |
| Gross Margin %                    | 10%       | 20%        | 50%         | 60%         |
|-----------------------------------+-----------+------------+-------------+-------------|
| *Gross Profit = Revenue - COGS*   |           |            |             |             |
| *GM pct = Gross Profit / Revenue* |           |            |             |             |


** Financial Table: Operating Expenses

| Category                   |          2015 |           2016 |            2017 |            2018 |
|----------------------------+---------------+----------------+-----------------+-----------------|
| Sales & Marketing          |   ₪500,000.00 |  ₪4,000,000.00 |  ₪66,500,000.00 | ₪112,455,000.00 |
| % of sales                 |           25% |            20% |             19% |             17% |
| % YOY                      |               |                |                 |                 |
|----------------------------+---------------+----------------+-----------------+-----------------|
| General & Administrative   |   ₪500,000.00 |  ₪4,000,000.00 |  ₪66,500,000.00 | ₪112,455,000.00 |
| % of sales                 |           25% |            20% |             19% |             17% |
| % YOY                      |               |                |                 |                 |
|----------------------------+---------------+----------------+-----------------+-----------------|
| Research & Development     | ₪4,000,000.00 | ₪20,000,000.00 |  ₪24,500,000.00 |  ₪26,460,000.00 |
| % of sales                 |          200% |           100% |              7% |              4% |
| % YOY                      |               |                |                 |                 |
|----------------------------+---------------+----------------+-----------------+-----------------|
| *Operating Expenses Total* | ₪5,000,000.00 | ₪28,000,000.00 | ₪157,500,000.00 | ₪251,370,000.00 |


*** Operating Expenses
these can also be found in every company

- Sales & Marketing
- General & Administrative
- Research & Development

*** how to calculate
1. go see similar publicly traded companies and find out what percent of revenue/sales
   - security and exchange commision requires all publicly traded companies to put this up
2. from the initial point we make assumptions

** Operating Profit (EBIT)
- the company is breaking even when Total Operating Expenses equals or exceeds Gross Profit
- In the example, this occurs in year 2017

\[ \text{Operating Profit (EBIT)} = \text{Gross Profit} - \text{Operating Expenses Total} \]

*** Key Components of EBIT
1. *Revenue*: Total income from sales or services.
2. *COGS (Cost of Goods Sold)*: The direct costs of producing the goods or services sold by the company.
3. *Gross Profit*: Revenue minus COGS.
4. *Operating Expenses*: Costs not directly tied to production, such as:
   - Sales & Marketing
   - General & Administrative (G&A)
   - Research & Development (R&D)

*** Why EBIT Is Important
1. *Operational Focus*: EBIT shows how efficiently a company runs its operations without considering external factors like financing (interest) or tax obligations.
2. *Comparison*: Useful for comparing companies in the same industry, as it ignores the effects of different tax rates and financing structures.
3. *Profitability Analysis*: Highlights whether the core business is profitable.

** What is YOY?
*** Definition
YOY stands for *Year-over-Year*. It is a method of comparing data from one period (usually a year) to the same period in the previous year. YOY is often used in business, finance, and economics to evaluate *growth*, *performance*, or *trends* over time.

*** Formula
\[ \text{YOY % Change} = \frac{\text{Current Year Value} - \text{Previous Year Value}}{\text{Previous Year Value}} \times 100 \]

*** Why YOY Is Important
1. *Growth Analysis*: YOY highlights whether a metric (like revenue, profit, or expenses) is increasing or decreasing compared to the previous year.
2. *Seasonal Neutrality*: YOY comparisons help account for seasonality, as the same time periods are compared.
3. *Trend Insights*: Helps identify long-term trends and patterns by consistently comparing yearly changes.

*** Example
Calculate YOY for *Revenue*:

| Year | Revenue (₪)       | YOY % Change                                   |
|------|-------------------|-----------------------------------------------|
| 2016 | ₪20,000,000.00    | \((20,000,000 - 2,000,000) / 2,000,000 \times 100 = 900\%\) |
| 2017 | ₪350,000,000.00   | \((350,000,000 - 20,000,000) / 20,000,000 \times 100 = 1650\%\) |
| 2018 | ₪661,500,000.00   | \((661,500,000 - 350,000,000) / 350,000,000 \times 100 = 89\%\) |
| 2019 | ₪999,600,000.00   | \((999,600,000 - 661,500,000) / 661,500,000 \times 100 = 51\%\) |
| 2020 | ₪1,399,440,000.00 | \((1,399,440,000 - 999,600,000) / 999,600,000 \times 100 = 40\%\) |


*** Updated Financial Table
| Year                              |       2015 |        2016 |         2017 |         2018 |         2019 |           2020 |
|-----------------------------------+------------+-------------+--------------+--------------+--------------+----------------|
| Revenue                           | ₪2,000,000 | ₪20,000,000 | ₪350,000,000 | ₪661,500,000 | ₪999,600,000 | ₪1,399,440,000 |
| COGS (Cost of Goods Sold)         | ₪1,800,000 | ₪16,000,000 | ₪175,000,000 | ₪264,600,000 | ₪299,880,000 |   ₪279,888,000 |
| Gross Profit                      |   ₪200,000 |  ₪4,000,000 | ₪175,000,000 | ₪396,900,000 | ₪699,720,000 | ₪1,119,552,000 |
| Gross Margin %                    |        10% |         20% |          50% |          60% |          70% |            80% |
| YOY                               |          0 |        900% |        1650% |          89% |          51% |            40% |
|-----------------------------------+------------+-------------+--------------+--------------+--------------+----------------|
| *Gross Profit = Revenue - COGS*   |            |             |              |              |              |                |
| *GM pct = Gross Profit / Revenue* |            |             |              |              |              |                |

*** Uses of YOY
1. *Revenue Growth*: Are sales increasing year over year?
2. *Expense Management*: Are costs growing faster than revenue?
3. *Profitability Trends*: Is the business becoming more or less profitable over time?
4. *Operational Insights*: Are marketing or R&D expenses increasing efficiently year over year?

** taxes and interest
|                               | 2015       | 2016         | 2017          |
|-------------------------------+------------+--------------+---------------|
| Revenue                       | ₪2,000,000 | ₪20,000,000  | ₪350,000,000  |
| COGS (Cost of Goods Sold)     | ₪1,800,000 | ₪16,000,000  | ₪175,000,000  |
| Gross Profit (Revenue - COGS) | ₪200,000   | ₪4,000,000   | ₪175,000,000  |
| Total Operating Expenses      | ₪5,000,000 | ₪28,000,000  | ₪157,500,000  |
| EBIT (Gross Profit - TOE)     | -₪4,800,00 | -₪24,000,000 | *₪17,500,000* |
| Interest                      |            |              | ₪85,000.00    |
| Tax                           |            |              | ₪4,250,000.00 |
| % of EBIT                     |            |              | 24.29%        |

*** % of EBIT formula
\[
\text{Tax as \% of EBIT} = \left( \frac{\text{Tax Amount}}{\text{EBIT}} \right) \times 100
\]

*** Why No Taxes Before 2017?
**** Taxes Are Based on Profit (EBIT)
   - Corporate taxes are typically calculated as a percentage of **profit** (Earnings Before Interest and Taxes, EBIT).
   - If the EBIT is **negative** (i.e., the company has an operating loss), there’s no taxable income, and thus no corporate income tax is owed.

**** Losses in 2015 and 2016
   - EBIT values:
     - 2015: -₪4,800,000
     - 2016: -₪24,000,000
   - Since the company had **operating losses** during these years, there was no taxable profit.

**** Profit in 2017
   - EBIT in 2017: ₪17,500,000.
   - By 2017, the company had a positive EBIT, meaning taxable profit existed, and taxes were applied from that year onward.

*** How Losses Affect Taxes -  Loss Carryforward
- Many tax systems allow companies to carry forward losses from previous years to offset future taxable income.
- Loss carryforwards reduce taxes owed in profitable years.

*** No Tax Obligation Without Profit
   - If a company doesn’t generate profit, it generally doesn’t pay income taxes.
   - Other taxes (e.g., payroll, VAT, property taxes) may still apply.

*** Conclusion
   - Taxes weren’t calculated before 2017 because the company didn’t have taxable profit.
   - Once the company turned a profit in 2017, taxes were applied.

** IP Valuation: Growth vs Value
- *Assume an Initial Public Offering (IPO) in 2020*
- Based on the Financial data given, how and what will different types of investors PAY for this company

| Category                        | 2020              |
|---------------------------------+-------------------|
| Revenue                         | ₪1,399,440,000    |
| EBIT (Gross Profit - TOE)       | ₪657,736,800      |


*** Growth Investors
- focus on *revenue* as the primary metric
  - especially for high growth companies
  - take the revenue in the year of the IP and multiply it by 10, that is what they expect the company will be worth in 5 years

\[
\text{Growth Investor Valuation} = \text{Revenue for IPO Year} \times 10
\]

*** Value Investors
- they look on the long term viability of a product vs it's fast growth
- buy cheap, sell after many years
- focus on *current profitability* (earnings, ie EBIT)
  - lower valuations for high growth companies
  - high growth companies reinvest profits into expansion, research, etc.

\[
\text{Value Investor Valuation} = \text{EBIT for IPO Year} \times 10
\]

*** Final valuations based on 2020 IPO
assuming the IPO takes place in 2020 our valuation will be

| Investor type    | Formula      | Projected Valuation in 5 Years (2025)  |
|------------------+--------------+----------------------------------------|
| Growth Investors | Revenue x 10 | *₪13,994,400,000*                      |
| Value Investors  | EBIT x 10    | *₪6,577,368,000*                       |

** sustainabile growth
*** how it works
- sustainable growth is the maximum growth rate a company can achieve without additional equity or debt financing

        \[
        \text{Sustainable Growth} = \frac{ \text{ending equity} -  \text{beginning equity} }{\text{beginning equity}}
        \]
- you want to grow BELOW the sustainable growth rate so as to not require outside help

*** basic example
  | sustainability growth example |                  |
  |-------------------------------+------------------|
  | beginning equity              | $    351,597,690 |
  | ending equity                 | $    860,108,490 |
  | sustainable growth rate       |             145% |
  | 2020 growth rate              |              98% |

- not sure where he got the values for beg and ending equity.  assuming it's from somewhere else because it doesn't actual match up

- the values for growth rate probably come from EBIT or operational revenue, and if calculated using the growth rate formula, come out to 94% not 98%

*** More extensive Example where dividend are 0

| Column Name               | Value          | Formula / Notes                                       |
|---------------------------+----------------+-------------------------------------------------------|
| Year                      | 2020           |                                                       |
| Revenue                   | ₪1,399,440,000 |                                                       |
| COGS (Cost of Goods Sold) | ₪279,888,000   |                                                       |
| Gross Profit              | ₪1,119,552,000 | Revenue - COGS (Cost of Goods Sold)                   |
| Operating Expenses Total  | ₪461,815,200   |                                                       |
| Operating Profit (EBIT)   | ₪657,736,800   |                                                       |
| Interest                  | ₪85,000        | Given                                                 |
| Tax                       | ₪159,764,269   | Assuming tax rate of 24.29%                           |
| Net Income                | ₪497,887,531   | Operating Profit - Interest - Tax                     |
| Beginning Equity          | ₪699,720,000   |                                                       |
| Ending Equity             | ₪1,197,607,531 | Beginning Equity + Net Income                         |
| Average Equity            | ₪948,663,765.5 | (Beginning Equity + Ending Equity) / 2                |
| Dividend Payout Ratio     | 0.00           |                                                       |
| ROE (Return on Equity)    | 52.48%         | Net Income / Average Equity                           |
| Sustainable Growth Rate   | 52.48%         | ROE * (1 - Dividend Payout Ratio)                     |
| Actual Growth Rate        | 71.16%         | (Ending Equity - Beginning Equity) / Beginning Equity |

- here beginning equity was based on 2019 Gross Profit
- different beginning equity values lead to VASTLY different results
- NOTE: you can see that the Sustainable Growth Rate, is very far bellow the Actual Growth Rate with 52.48% to 71.16%

*** example where a dividend payout of 44% was expected


| Column Name               | Value          | Formula                                               |
|---------------------------+----------------+-------------------------------------------------------|
| Year                      | 2020           |                                                       |
| Revenue                   | ₪1,399,440,000 |                                                       |
| COGS (Cost of Goods Sold) | ₪279,888,000   |                                                       |
| Gross Profit              | ₪1,119,552,000 | Revenue - COGS (Cost of Goods Sold)                   |
| Operating Expenses Total  | ₪461,815,200   |                                                       |
| Operating Profit (EBIT)   | ₪657,736,800   |                                                       |
| Interest                  | ₪85,000        | Given                                                 |
| Tax                       | ₪159,764,269   | Assuming tax rate of 24.29%                           |
| Net Income                | ₪497,887,531   | Operating Profit - Interest - Tax                     |
| Beginning Equity          | ₪699,720,000   |                                                       |
| Ending Equity             | ₪1,197,607,531 | Beginning Equity + Net Income                         |
| Average Equity            | ₪948,663,765.5 | (Beginning Equity + Ending Equity) / 2                |
| Dividend Payout Ratio     | 0.40           |                                                       |
| ROE (Return on Equity)    | 52.48%         | Net Income / Average Equity                           |
| Sustainable Growth Rate   | 31.49%         | ROE * (1 - Dividend Payout Ratio)                     |
| Actual Growth Rate        | 71.16%         | (Ending Equity - Beginning Equity) / Beginning Equity |

- note the Sustainable Growth rate is worse at 31.49%
- incidentally if I try to change the Beginning Equity to a different metric, ie such as revenue which is around 999m, the SGR becomes EVEN WORSE

*** retained earnings
- part of equity
- how much profit derived over the years

** playing with equations

*** go through the following equations
1. \[\text{ROE (return on equity)} = \frac{\text{net income}}{\text{equity}} \]
2.
   \[\text{ROE (return on equity)} = \frac{\text{net income}}{\text{equity}} \times 1 \times 1 \]
3.
   \[\text{ROE (return on equity)} = \frac{\text{net income}}{\text{equity}} \times \frac{\text{sales}}{\text{sales}} \times \frac{\text{assets}}{\text{assets}} \]

4.
   \[\text{ROE (return on equity)} = \frac{\text{net income}}{\text{sales}} \times \frac{\text{sales}}{\text{assets}} \times \frac{\text{assets}}{\text{equity}} \]

*** Lets break down this equation and define its parts
**** first define ROE as Growth
\[\text{Growth (ROE ie. return on equity)} = \frac{\text{net income}}{\text{sales}} \times \frac{\text{sales}}{\text{assets}} \times \frac{\text{assets}}{\text{equity}} \]

**** now define the other parts of this equation
   1. Net Profit Margin is Net Income over Sales
      \[
        \text{Net Profit Margin} = \frac{\text{net income}}{\text{sales}}
      \]
   2. Asset Turnover is Sales over Assets
      \[
        \text{Asset Turnover} = \frac{\text{sales}}{\text{assets}}
      \]
   3. Equity Multiplier is Asset over Equity
      \[
        \text{Equity Multiplier} = \frac{\text{assets}}{\text{equity}}
      \]
*** redefine the equation

  \[\text{Growth} = \text{Net Profit Margin} \times \text{Asset Turnover} \times \text{Equity Multiplier} \]

by increaseing one of the three parts of the equation you can increase growth
1. Net Profit Margin
2. Asset Turnover
3. Equity Multiplier
