CHAPTER 4
Applying the Typical DCF Model to a Venture-Backed Company Hardly Ever Works
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.”
—Albert Einstein
As mentioned, the DCF, or discounted cash flow, method is an income approach to valuation, for the most part. I say for the most part because as you will quickly realize, once we get beyond the cash flows we can “see” or “forecast” reasonably, there has to be a means to account for the value that exists beyond the forecast period. This is often called the “terminal value,” but is referred to by some as “residual value,” “continuing value,” or “horizon value.” In the case of venture-backed companies, that “terminal value” is in practice the second most important element driving fair market valuation outcomes, with interim venture financing rounds being the first. As a result, we are going to spend a little time reviewing some of the most popular ways of calculating terminal value for all companies before discussing if, and when, these models apply to venture-backed companies.
THE GORDON GROWTH MODEL
One of the most popular methods of estimating residual value beyond the forecast period is the Gordon Growth Model and variations of it. It's popular, in part, because it is relatively easy to implement and because it's easy to prove the math and logic behind it. It's also worth memorizing for anyone outside of the finance profession, since even if it doesn't fit your ...
