Sunday, 23 August 2015
Would you like any Discounted Cash Flow with your chips? No Ta!
Can we all please agree that using the discounted cash flow valuation model for start ups and early stage Co's is a complete nonsense.
So why do they do it?
To be fair they dont all do it, but a recent example gives us a clue as to why the more naive try it.
Mara Seaweed, featured here for its outstanding valuation and ridiculous net profit margins, has now declared that it used DCF - via their accountants calculator - to come up with £3.5m valuation. Apparently as the accountants made the calculation, it is sound.
Rule number one when using DCF is that the depth of histrical data should be sufficient to give confidence in the projected future cash flows. Clearly being a start up this data does not exist for Mara. Putting the wrong figures into a calculator generally results in a false reading.
Rule number two, is that the ratios used must be tried and tested. Mara has a net profit margin of around 35% when its 'valuation' is calculated - it hasnt achieved anything like this yet. There is no evidence from any market or from the company that this NPM is achievable at these turnover levels. It is a figure plucked from thin air or rather one worked backwards to allow a high valuation.Putting your own imaginary figures into a calculator will always produce your own answer.
There's the rub. This whole ludicrous process is being driven by the valuation - it is supposed to be the other way around.
Mara have shown already just how naive they are when it comes to business - see Dragons Den. They have refused to accept a single of the many sound arguments put forward on Crowdcube for a more realistic valuation. Now they have admitted to using a totally inappropriate calculation technique to endorse this valuation.
Our bet is they will lower the valuation in a week or so when they are still around £100k short; by which time any right minded person would have concluded that the whilst the product is of interest the management have some serious issues.