Startups – Potential to Flourish

A new venture is always exciting and premised with good intentions, but care should be taken to appropriately address risks associated with establishing a new business in the market.

On the back of the recent Australian startup, Unlockd, going from potential IPO to voluntary administration in the space of weeks, this article explores some risks and considerations that business owners and their advisers should address ahead of a full launch.[1]

With reference to a real-life case-study; In 2016, Unlockd launched an app which rewards users for watching advertisements. The company built its business by using Google’s AdMob inventory to source most of its advertising content and had a reliance on the Google Play Store to feature its apps. When the potential IPO of Unlockd was communicated to the market, Google warned that it would withdraw its access to Google Play and AdMob services (citing a breach of a number of its policies). Unlockd claimed that it had received approval for its app for use with AdMob, “following exhaustive testing”.

A statement from Unlockd said the “ramifications of Google’s actions have had and continue to have a deep impact on the business when considering the valuation of Unlockd prior to these threats and the postponement of the planned IPO, which would have fuelled the continued growth and expansion of the business. As such, we have not been able to secure the capital we had expected to replace the IPO and therefore have been left no choice but to move into voluntary administration.”

Highlighted below are some key considerations, from a valuation perspective, when launching a new venture:

  • Risk adjusted cash flows – New ventures typically exhibit financial cash flow projections with high growth assumptions. Further, there are likely to be several future potential growth scenarios. It’s important to risk adjust the cash flows and probability weight possible scenarios, to determine a reasonable data-set for all stakeholders to work with, and make informed decisions upon. In addition, professional scepticism should be applied to challenge the key assumptions and inputs to the financial projections.
  • Discount rate – Required equity returns applied in the valuation of early stage high growth ventures are typically in the range of 20% to 35% for IPOs, and anywhere in the range of 50% to 100% for pure startup operations[2]. This reflects the inherent risks involved, which matches the cash flow profile, however also displays that the potential rewards could be great.
  • Do the Valuation outcomes make sense? – Carefully consider if outcomes are reasonable, in terms of being both technically robust and commercial sound. Valuations (particularly in the case of startups) have many subjective elements, so it’s important to ‘triangulate’ results using a number of methods, and engage the unique skills of a valuation expert where possible.
  • Operating model – Does the business have a dependency on key external suppliers, i.e. Google in our case-study above, and/or a highly concentrated customer base? A certain level of diversification may be worth it in the long-run.
  • Maintain control of key assets – It’s important to build a defined strategy around the intangible elements of your business. This includes establishing controls in respect of retaining ownership and protecting the value of key intangible assets, including customer lists, brands, supplier contracts, software and other intellectual property.[3]
  • Get it in writing – Liaise with a qualified legal practitioner and ensure that key agreements with third-parties are appropriately documented. Consider the situation above between Unlockd and Google.
  • Communication – The style and level of communication with the market and key stakeholders, including potential cornerstone investors is critical. Implications of a poor communication strategy can impact the ability to secure capital and instil a lack of confidence in your business proposition in the market.
  • Embrace advice – The success of an entrepreneurial vision will not occur within a vacuum. Surround yourself with key advisers and good management, each of whom bring a different viewpoint and diverse array of important skills, to enable your business venture to grow and flourish.

By no means is the above list exhaustive, and there are typically many additional risks/matters that should be considered when embarking on a growth strategy.

A new venture has the potential to flourish and return extraordinary returns, but it is not without risk. Business owners and investors should ensure that all potential risks are duly considered. Economy and growth thrives on entrepreneurialism, but not without good measure and regard to commercial realities.

Nicole Vignaroli, Partner – Corporate Finance

[1] Note that the Unlockd situation is used as a case-study only, and the commentary within this article should not be intended to opine in any way in regards to the business operations, outcomes of recent events or actions taken by any party involved.

[2]Based on various empirical studies including Plummer, Sscherlis & Sahlman, Sahlman, Stevenson & Bhide and Harvard Business School

[3]Also see my article “Brand: Strategy, Valuation and Protection”