The Little Book of Valuation, Updated Edition

Chapter SixPromise Aplenty: Valuing Young Growth Companies

IN LATE 2012, FACEBOOK (META) attempted to buy a young tech company called Instagram for $1 billion. At the time, Instagram had been in existence for only two years, had barely any revenues, and was reporting operating losses. The firm clearly had growth potential, but there were huge uncertainties about its business model. In assessing the bid, analysts were nonplussed, unsure about how to value a company with almost no operating history and market price data.

If every business starts with an idea, young companies can range from idea companies (those with no revenues or products) to start-up companies that are testing out product appeal to second-stage companies that are moving on the path to profitability. Figure 6.1 illustrates the diversity of young growth companies.

Most young growth companies tend to be privately owned and funded, either entirely by their founders/owners or by venture capitalists. In the last two decades, though, companies in some sectors such as technology and biotechnology have been able to leapfrog the process and go public. When they do go public, they offer a blend of promise and peril to investors who are willing to grapple with the uncertainties that come with growth potential. Young companies share some common attributes:

Figure 6.1 The Early Stages of the Business Life Cycle

• No historical ...