business-haroun/mba/ch50.org

Section 9 | Lesson 50 - How to Value Private Companies and Growth Methods

• Links
• Notes
  • Financial Table
  • Financial Table: Operating Expenses
    • Operating Expenses
    • how to calculate
  • Operating Profit (EBIT)
    • Key Components of EBIT
    • Why EBIT Is Important
  • What is YOY?
    • Definition
    • Formula
    • Why YOY Is Important
    • Example
    • Updated Financial Table
    • Uses of YOY
  • taxes and interest
    • % of EBIT formula
    • Why No Taxes Before 2017?
      • Taxes Are Based on Profit (EBIT)
      • Losses in 2015 and 2016
      • Profit in 2017
    • How Losses Affect Taxes - Loss Carryforward
    • No Tax Obligation Without Profit
    • Conclusion
  • IP Valuation: Growth vs Value
    • Growth Investors
    • Value Investors
    • Final valuations based on 2020 IPO
  • sustainabile growth
    • how it works
    • basic example
    • More extensive Example where dividend are 0
    • example where a dividend payout of 44% was expected
    • retained earnings
  • playing with equations
    • go through the following equations
    • Lets break down this equation and define its parts
      • first define ROE as Growth
      • now define the other parts of this equation
    • redefine the equation

Links

• TOC | Business
• S09:L50. How To Value Private Companies the Easy Way & Growth Methods
• tables: 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