trying to value a startup - assumed required rate of return

i’m trying to come up with a valuation of a tech startup based on the Gordon Growth Dividend Model. Yes, I’m aware that this model assumes a static rate of growth, so I had to adjust the model for a few years of hypergrowth and then a constant R value once the company reached a stage of maturity.

Regardless, my question was what I should use as a K value, or the required rate of return.

For example, assuming next year’s di vidend = 7 million, a K value of 12% and a modest growth rate of 5%, then

7 million / (.12-05) = 100M

Where did I get the 12% for K? Well I figured that Bernie Madeoff promised 12% a year consistently and we all know he was full of shit, so I hesitated to place a required rate of return above 12%.

  1. Would it be a reasonable thing to test with a 20% required rate of return or even a 30% rate of return if someone made the argument that most new/small companies fail?

  2. What if I made the argument that this company was in the top 1% of new companies, based on month-over-month growth, VC backing, and run rates?

  3. What if this company showed certain internal strengths and oppurtunities that most companies don’t have?

I know valuation is both an art and a science but I just want to make sure I’m in the right ballpark here.

You are not in the right ballpark.

Nor are you in the right forum.

yeah mods feel free to move this, I posted in the wrong forum.

Okay, well how would you go about in approaching this?

Gordon Growth Model is basically for mature dividend paying companies, and startups don’t really fit.

Nonetheless, I suppose it’s ok to try this just for ballpark back-of-the-envelope calculations - usually one would take an EBITDA multiple, adjust it subjectively for risks, and call it a day.

The required rate of return should be tuned to the risks of the company, and you would most likely go through the same thought process with any discounted cash flow model. I’d be inclined to look at the ROA or ROIC (or alternatively, the unlevered equity returns) of comparable public companies, then lever them back up to whatever D/E ratio your startup has to get a sense of what the equity returns should be if it were an established, public company. Then you’d lop on a liquidity premium (say 10%, and maybe an additional premium to compensate for the fact that lots of startups fail). I could definitely see a required return of 20-30% being possible here if it’s private and a startup and perhaps even more if there is no obvious competitive advantage.

For a startup, you really can’t do the GGM, because the whole point of startups is to capture substantial growth from innovation and/or being bought out. At a very minimum, you’re going to need some kind of projected growth for a few years, and then a terminal value at IPO or buyout, and that usually gets done as an EBITDA multiple rather than assuming the GGM stuff.

3 x EBITDA unless they sell u the dream of being the next uber…then it’s 5x

Also, when it comes to startup risks, there’s a good chance you’re going to get your equity diluted, so that will add a huge premium to required return.