Here at Scalar, we believe every valuation should be treated as a unique case. Many of our clients are generating revenue, growing steadily, and produce positive operating income.
However, we also work with many pre-revenue companies who are unsure about their future financial performance. In these cases, typical valuation methods (eg., cost, market, and income approaches) would not be appropriate. Often, a backsolve is the most relevant methodology.
What is a backsolve?
The transaction backsolve method is an application of option-based valuation. If the subject company recently raised money via an arm’s-length transaction, the price paid by investors is considered a relevant indication of value. For example, if a Series A was raised at $1.00/share, we backsolve to find an equity value that returns a share value for Series A at $1.00 while taking into account the different economic preferences (eg., liquidation rights, participation rights, seniority, and dividends) of all the classes of stock. This is achieved by using the Black-Scholes option-pricing method.
Typically, the backsolve method is only considered if the transaction occurred within one year. However, with pre-revenue startup companies, this still may be the best indication of value—even if the transaction occurred more than a year ago.
When is it appropriate to use a market-adjusted transaction backsolve?
A market-adjusted transaction backsolve can be considered when the following requirements are met:
If the company meets the above requirements, then the backsolve (though outdated) may be the best indication of value. However, if the transaction occurred more than a year ago, the backsolve value will need to be adjusted to market.
What is a market-adjusted transaction backsolve?
When adjusting a backsolve value to market, we perform the following steps:
The idea behind the adjusted-transaction backsolve is that the original investors had placed a value on the company at the time of the original raise, which still holds as a relevant indication of value. While the company has not made any significant changes to the business, it is still in line with the internal expectations from the original investors; therefore, a market adjustment is needed.
This article is purely informative, and Scalar does not accept any responsibility for action taken based on the content of this article.