For a business with little or no revenue or profits and a less-than-certain future, determining a business valuation is tricky.  The traditional way of valuing a business using a top down DCF model is problematic as the valuation relies on unsubstantiated forecasts of revenue and costs into the future.  Using multiples ( of revenue for example) also has problems, as a simple number – the multiple, tries to distil a great number of (hidden) assumptions around growth, price and costs as well as customer metrics such as CAC and churn and even whether the company has a profitable byusiness model.  Finding a comparable company, that has a valuation is also problematic.

A new approach, described by Professor Peter Fader from Wharton Business School and applied by Professor Aswath Damodaran at NYU, is based on a calculation of customer lifetime value(CLV).Copperstone Capital have extended this approach by adding an options theory based front end to account for the high levels of risk in a startup.  The benefits of this approach are multiple; the calcualtion is a DCF calcualtion with well known inputs; the valuation estimates key drivers such as Customer Acquisition Costs(CAC) and retention rates explicitly; the CLV can be used in place of operating asset valuations in a traditional valuation model; business risk is accounted for in the discount rate, whereas startup risk is accounted for in an option theory approach.

The base calculation is to calculate a complete customer lifetime value(CLV), which can be described as the average revenue received each year from a customer over their lifetime less the costs of servicing that customer.  The margin is then discounted back to the present by a cost of capital. New customers are acquired by spending the CAC, so a new customer is valued at New Customer Value = CLV – CAC.  So the value of the buiness can be calculated as the value of the existing customers + value of new customers over the forecast period – value of overheads.