Valuation of a rapidly growing firm

Water Cooler Investing
#1

Hello folks,

I am working in a PE firm, and recently got an interesting target with more 10+ years of existence. The firm recently started a rapid growth (30%+ CAGR) in sales. They aim to increase the sales by 700% in the next 5 years. Here, I need your help considering the following factors:

  1. I need to calculate an investment return estimate for our committee review;

  2. The management estimates on 700% sales growth can be realized by only an equity investment, namely, that estimate relates to post-money sales;

  3. As part of rapid expansion, operating margins will change significantly, but due to 700% growth factor, it is impossible to forecast the range of change.

Considering the factors above, I feel I need to utilize a Venture Capital Valuation Method by first deriving terminal stage value of the firm by multiplying average P/S multiple of the industry with the revenue target of the firm, and then assuming it as Post-Money valuation, discounting it back to today, and deducting our investment to find eventual Pre-Money valuation. Here, I can calculate my return by assuming no dividend during the investment horizon and terminal value as my exit valuation, and derive my IRR based solely on exit valuation.

At this point, i would like to get your views on this case? What would you rather? Undertaking comprehensive DCF valuation or Venture Capital Method? Or else, what would you recommend me to read as a material, or source that I can refer?

I do appreciate your time allocation to my case, and I do thanks to all in advance.

#2

I always do DCF, you need to understand actual cash flows in various scenarios. DCF is how you find out where people are lying about their “totally awesome revolutionary business idea that will save the world” (they are always lying somewhere).

Could do that very high growth rate including changing margins—and then also use a high discount rate, or probability weight that “high” scenario with a “low” scenario.