The Art of Valuation

Sanjit Dang, Chairman & Co-Founder @ U First Capital; Jordan French, Executive Editor & Co-Founder @ Grit Daily
Ascent Conference 2019

Jordan French [00:00:06] For those who don’t know him, Principal, you first capital founded it, he was formerly at Intel Capital, making a lot of investments. He’s had an exit every single year, 50 50 million is what he’s managing under a family of funds that just some foundation. I do want to jump right in. Sanjid, because valuation is a hot topic right now. We just saw a debacle where we work. We saw some other issues in public markets. But I want to ask you this sort of quintessential question so people can understand how do you invest?

Sanjit Dang [00:00:43] First of all, thank you very much to the U.S. team for inviting me here, and thank you very much, Jordan, for all your hard work as well. Thank you. You know, it’s a big question. How do you invest? But I’ll try to distill it down to four factors that I always look for. And I have also refined some of these factors over the years through my investing career. One is the team. Second is the market. And more importantly, not just a market size, but market timing. Why now? Number three, is the product market fit? And then number four is how well can they execute which kind of ties to the team? And I can go into more details, but those are really the top factors that I look at when I am investing in a company.

Jordan French [00:01:35] And before this, before we hopped up on stage, we talked about what you call the learning curve. There’s one of those that is most often what investors get wrong.

Sanjit Dang [00:01:48] You know, most investors I’m talking of companies when they are raising money at a private stage. So when they are raising money from private investors, they are pitching here. It is the team. Look at the domain expertize blah, blah, blah, looks all great. It is a market I’m going after. Here is a product I’m going to build. Everything looks great. A lot of the investors invest, but two or three years later, they figured out the market timing was not right. In fact, I would say that most companies fail not because they had a bad team or a bad product. But they were either too early or too late to the market. And that that has been a big learning for me as well. Why now is the biggest question that you as an entrepreneur need to answer, not just for the investor or more for yourself. Why are you building this now as an example, if somebody pitches and says, hey, health care system is broken in the US. Oh, great. I didn’t know this, no one heard about it, and the drugs are expensive. There’s no cure for cancer. All right, great. I never knew about it. But why is the health care market ready to adopt a new cancer solution now versus two years from now? That’s the question precisely that you need to answer as an entrepreneur when you are even starting a company. Before you when you pitched to the private investor.

Jordan French [00:03:25] Certainly, and you mentioned teams earlier, I want to set that aside for for just a minute and come right back to that. But this still begs the question, how how do these investors know? And so we’re all curious, how do we know that it’s the right timing? Is there a certain rubric perhaps that you use?

Sanjit Dang [00:03:40] So one of the things I always do is to check for the timing. We as investors keep a good network of buyers. So let’s say if you are an enterprise solution and Iot solutions, you’re likely selling to the CIO of I don’t know about this Cisco or if it’s a retail company, CIO of Macy’s, etc. So we keep a good network of those. So when you are pitching to us as part of my exercise diligence exercise, I will send you to three CEOs in my network. And it’s a win win win, you get a potential customer or a partner, the CEO gets to see a new piece of technology. Coming up, I get the CEO’s feedback and the CEO is not going to bullshit me and say, hey, oh, this is all great. No, I get red and green, but. So what I’m looking for at that time is more like a survey answer from multiple CEOs here, multiple CEOs. Hey, is this something that I’m ready to adopt and pay for now? Well, yeah, it’s great. Nice team, nice technology. Building a great new community solution for the storage world. Awesome. But I’ll think about it next year. And the other subplot to keep in mind is because you are selling typically to especially for B2B companies, you’re selling to corporations. Corporations have spending predefine for the year budgetary line items. So you have to start thinking about which line item. Am I going to be part of? If you cannot map yourself to that to a line item or more on their financial spending forecast, you’re not going to get the money,.

Jordan French [00:05:33] Certainly. And I want to I want to drill down on your example some more, because so far in this scenario, we have an intro to three Sexo is probably Osseo in this scenario. What is the condition that must be met, though, after that introduction in order for you to invest?

Sanjit Dang [00:05:50] So I would like to hear from them that No. One, this is of extremely high interest and they are putting a team, their internal team, to take next steps, number one. Number two, are they ready to start a pilot? A page pilot. Today. So they are great, let’s chat in six months or a year. I’m looking for those signals and sometimes the product is not built or is not ready for adoption, that’s fine. But the CIO will give me the signal of hey. If this was a product, here’s what I am ready to declare today for the pilot, because I really need it.

Jordan French [00:06:28] So in therapy it is back to you. Money has to change hands.

Sanjit Dang [00:06:32] Money has to change hands. And as a company, if you are not getting paid even only on small amounts, 20 50 K, if you’re not getting paid, you should ask yourself, why am I doing this? Right, then you are not creating enough value and it all ties back into finally into your valuations, you’ll not be happy about the valuations because you never got paid enough for the customer. It’s all tied together.

Jordan French [00:07:00] Sounds like there should be a salesperson on the team or some capacity for speaking of teams. We did set that aside. I want to bring that back front and center and explore that to it’s not just enough, like you said earlier, to have the right product market fit and it sounds like induce what amounts to a sale. Who should be doing that? What are the characteristics of that team that should put that into play.

Sanjit Dang [00:07:23] At an initial stage of a private company? It’s more about the founders is as even as the founders becoming the salesmen themselves, because the founders themselves don’t know exactly whether this product is going to sell verbatim or do I have to modify the product. So it’s best if the founding team is also doing the initial sales and it’s not really sales at that time. It’s almost like market validation. And then they can take that feedback and iterate on the product as well. So initially, I’m not looking for a Rockstar sales guy. I’m looking for somebody who can actually articulate. To the customer, what they are doing exactly, and I look for that articulation in my meetings with the team as well. A lot of the times I actually, in pictures some entrepreneurs have pitched to me over the years, 10 minutes into the presentation, I shut down the projector. And if I don’t shut down the projector, that’s a bad sign for you as an entrepreneur, which means I’m not interested in your company. Ten minutes into the meeting. If I’m really interested in the company 10 minutes into the meeting, I’m going to shut down the projector and start doing a whiteboard session with you. And that’s part of my team diligence because I’m less interested in precancer beautiful marketing pitch deck. Prepared by somebody else for you, I’m more interested in what is in your mind, are you crystal clear about the problem? Can you articulate it well, if you can’t articulate it to me as an investor, how will you articulate it to a future employee or a customer? So that’s part of the team d’elegance.

Jordan French [00:09:08] We can feel ourselves in that room, in that pitch, Sangeet, we’re all sweating. You asked him a specific question, though. You turn off the projector and you ask.

Sanjit Dang [00:09:18] I basically ask them here, give me down to. A pinpointed level, what you are doing and why and why now? There is nothing that you can’t answer in 10 words at that time if you are really clear about what you are trying to do, if you cannot answer. I used to have a manager. I learned it from a manager back then. My first job, I would walk into the manager’s office and she would say, N-word, Sanjit. So I actually imbibed it from her. So I use it for entrepreneurs. So I said on the projector and I say 10 words. And most of the time, the entrepreneurs are struggling, which, first of all, to say and that time you get to know and to be honest, I’m not trying to pull them down or anything. I’m trying to, to some extent, help them also articulate very clearly what they are doing and why.

Jordan French [00:10:14] 10 words being a super key nugget. We also had an earlier nugget on UN sales, just to reiterate that if you get the intro, better make a sale. Always generates money, is not is not following up move or just just a little bit because I want to layer down one trench, early stage, it sounds like, because there’s not a lot to go on. It’s a relatively narrow range seed and a can you share how investors should be thinking about what that range should be early on from a valuation standpoint?

Sanjit Dang [00:10:42] So valuations, you know, at an early stage seed series’s stage, you are really pitching to the investors heart. Once you get to Series B and beyond your pitching to the investors brain. That’s a key difference. You have to keep in mind when you are pitching to investors, depending upon the stage at seed series, if you don’t have revenue, you likely don’t even have a product built. So we can’t apply numbers, revenue multiples, etc., or receive any of those methods. We typically give you a valuation within a within a market, within a generally accepted range where the market and for seed stage valuations, it is between five to 10 million dollars of free money valuation in Silicon Valley. It does vary outside the US. It does vary to it’s lower. And even in the East Coast, I’ve seen. But typically it’s in that band and it’s more an art than science. Once you start getting to see this B and beyond, then you have revenue. We’re going to start applying multiples. For a fast company, maybe seven to 10, multiple, maybe higher, if you are growing faster. So the question comes down to is what stage you are at? And people worry a lot about valuations, which I understand why, but I think if they’re worried more about their customer attraction, valuations will follow.

Jordan French [00:12:13] And it sounds like for early stage, five to 10 million is really not that big of a bandwidth as perhaps I’ll articulate from what you said earlier. If it goes to a billion, that doesn’t matter. And if it goes to zero,.

Sanjit Dang [00:12:24] It doesn’t matter either. So if you become a unicorn getting to over a billion dollars in valuation, your seed stage valuation is irrelevant at that point.

Jordan French [00:12:33] And you mentioned a multiple use it, for example, for Satz companies, seven to 10. Where does that come from?

Sanjit Dang [00:12:41] So if you look at most using SAS, an example as an example, you can apply this to other sectors, real estate etc as well. If you look at the market multiples of publicly traded companies and private companies, you will typically find that all within a particular market, the generally accepted range and for size company that comes out to be seven to 10x of the revenue of the recurring revenue, I should say. If you want to go above that. That means you better show higher growth rate compared to those multiples. If you are not able to commando’s multiples in the market, that means you are not able to grow as fast as those multiples. Those those companies in that multiple band. So it’s not really rocket science, especially at this busy state. Now, if you get multiple investors vying for your company, then you know that’s a different story. Valuations can go pretty illogical.

Jordan French [00:13:41] Sure. And you mentioned revenues. That’s what these multiples are tied to. But we all know from retail investing, certainly from Wall Street profits are what matter. They’re focused on PE ratios, earnings, earnings calls each quarter. How do we square those two? Whereas a VC might be interested in revenues and what might come later down the road from from institutional and retail, the Wall Street level, which are interested in earnings and our profit.

Sanjit Dang [00:14:07] So. At the end of the day, it is irrespective of what Wall Street expects you to do, you should always march towards profitability or at least have a plan towards profitability. Every investor we see or the Wall Street investors will expect you to have that plan now we seize. Are more about helping the company grow. So they are forgiving about profitability because they believe the company is still in that sales learning curve or even product learning curve, that there will be inefficiencies, that that will hinder the path to profitability. But once you get past that stage, you have a sales execution engine in place. You know exactly what sells. You don’t have to spend sales dollars on trying out things. And because of that, you also have already had product feedback in terms of what product is selling. So your product execution engine is very streamlined as well, so that at that stage you better have either achieved profitability or B or have a path, a clear path towards profitability in the near term. Now, Wall Street investors are brutal about it and they should be. Because that’s why you started a company. If you started a company to run to generate 10 dollars of revenue and 15 dollars of expenses, why do it? Look at we look Aruba, look at, etc, etc., you could question that.

Jordan French [00:15:42] And let’s set aside those again for for just just a moment, because you mentioned a a pathway and there’s an obvious one we haven’t mentioned yet. One obvious endgame is to seek public markets through an IPO or equivalent. The other is to exit on the enterprise side. How should we be thinking about acquisitions? Or maybe best question is essentially what is in enterprise investors minds? Are they more focused on revenue or profitability?

Sanjit Dang [00:16:12] Typically, when a company like or using Oracle as an example, since there’s a logo here, a company like Oracle, etc., when they are looking to buy a startup, they are less excited about the revenue. The revenues, the startup’s revenue is not going to move the needle for the big companies revenue. They are more interested in the IP, the technology that you’ve have built. They are more interested in the team that you put together, hiring the right team with the right domain, expertize with the right learnings and the journey that you have gone through. That’s very valuable. So they are more interested in those things and then the potential disruption that this can generate for the big company in the next few years rather than the revenue today. So they are more forgiving in terms of profitability. They will look at revenue and they will they will give you a valuation based on your current revenue or the next year’s next 12 months projected revenue. And again, they will apply the market multiple to here is a market multiple as your revenue is a valuation I’ll give you now, then it’s from that point on, it’s a negotiation game, but that’s what they will aim for. And at that point, if you don’t like it, you don’t take it. Now Wall Street is brutal about show me the profitability for me.

Jordan French [00:17:33] And that’s a great Segway for what you brought up earlier. And I think I did way earlier, which was we work and we’ll talk about it one second. I just want to mention to the U.S. team, just just give us a flag for around the five minute mark. I do want to go to Q&A and make sure we have time for that. We have five now. Awesome. Perfect. So we’ll jump into it and then I’ll pop down there unless we can get a walking mike. But I want to ask what happened with the we work valuation. We started at forty seven billion. That was they were in a road show just to sort of peel the curtain back behind the scenes. And then again, for those who don’t know that got that got moved to around 20 billion. And now now we’re speaking of of at least from media bankruptcy. Can you unpack that for us?

Sanjit Dang [00:18:19] How many people here on real estate? So since a lot of you own real estate, would you buy real estate portfolio that is valued at 30 to 40 times your current revenue?

Jordan French [00:18:38] It was that a rhetorical question I’m going to answer now? It’s a collective probably no.

Sanjit Dang [00:18:44] We work was valued, like John said, at forty seven billion in January, twenty nineteen. Their revenue in twenty eighteen was one point eight billion, something like that.

Jordan French [00:18:54] But why?

Sanjit Dang [00:18:56] The reason for that is that was led by an investor called Softbank. That round was led by an investor called Softbank that has raised one hundred billion dollar fund and they have to deploy at least three hundred million in every deal. And there are only a handful of private companies. It’s a private fund. So they can apply, they can invest in Apple and Netflix, et cetera. Right. So there are only only very few fast growing private companies at that valuation that can take 300 million, 500 million or even a billion dollars of investment. We will happen to be one of them. And kudos to the CEO at that time for selling a good story to the investors. So he was able to get forty seven billion valuation and the management team and the Softbank team investment team, but all blindsided by what? The Wall Street would value this company ad, which should have been 10 billion,.

Jordan French [00:20:00] But but Softbank, they can’t be this inexperienced.

Sanjit Dang [00:20:05] They are very experienced people.

Jordan French [00:20:06] How could they get this so wrong?

Sanjit Dang [00:20:08] But the problem is they all get into this power of disruption. Most companies raise money at high valuation not because of the revenue they are actually, but because of the projection they are showing in five years. And if an investor buys into that, valuations today will go crazy.

Jordan French [00:20:29] And then it certainly begs the question because this sounds like a certain myopic on valuation early one decider as to what that number is.

Sanjit Dang [00:20:37] In a private round What typically happens is that when you’re raising, let’s say, ACTC around as an example, there is typically one lead investor. That lead investor means that investor is deciding the valuation and putting your sheets together. Every other investor has to buy into that term sheet. If you don’t like it, don’t invest.

Man speaking in the backgorund [00:20:56] And down to 30 seconds.

Sanjit Dang [00:20:57] Yeah, but there is one investor deciding the valuation.

Jordan French [00:21:02] Yeah. And that sounds like it can be a problem not just for employees, founders and other investors, but for that investor themselves that’s in permanent impairment of capital. We’ve time for one really quick question. I’m going to pop down here because I have a microphone to hand it to you. Would you say your name?

Audience [00:21:16] ¬†walk us through the early part of the valuation methodology for weeks when you said to sell CDs or or C, the investment that how do you think about it? That I’ll give one million at five million plus money valuation. But then what is the math behind it in terms of the exit will happen and how many years S.A.M. will be the value of the exit and then discounted back? I need to make 10x my money. What is the math that you apply?

Sanjit Dang [00:21:42] Typically at seed you will get a valuation of five to 10 million series A. Fifteen to twenty five million, so it is B, if you are growing nicely, 40 to 60 million and hopefully 100 million after that, from an investor standpoint, they are all hoping that you become the next billion dollar company for them. So not just Tenex, they’re hoping for 40, 50. It doesn’t happen obviously all the times, but that’s what they’re hoping for. So that’s a valuation range. And I’m giving you the numbers from what is typical in Silicon Valley and to a great extent in the East Coast as well.

Jordan French [00:22:22] Sanjit, we’re just getting started first. Thanks for your question. We’re out of time. Everyone give a big round of applause for your expert. You first capital. Thanks so much. We could go another hour with this one. I’m Jordan friend, GritDaily News. Until next time.