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Building a valuation model for online education business

Building a valuation model for online education business.

This note was written as a supporting document for a complete project submission for the Entrepreneurial finance course at Columbia Business School in Dec 2000. While the exhibits and excel files are dated, the process followed to build the online education model is still very relevant. If you would like to see an example with detailed step by step numerical calculations please see the following free cases:

Valuation model – Core steps

Step One – size of market, customer penetration, income and expense heads

  1. Identified Key Markets for online education users. Users included business school students, business school applicants, actuaries, small business owners and online investors.
  2. Estimated Market size and growth rates for each of the above target segments (business school students, business school applicants, actuaries, small business owners and online investors)
  3. Estimated product penetration rates for next five years for each of the target segments (business school students, business school applicants, actuaries, small business owners and online investors)
  4. Estimated income and expense items for next five years

Step Two – projected cash flows and valuation

  1. Modeled projected income statement and balance sheet for five years
  2. Projected Free Cash flows for next five years
  3. Estimated three different discount rates for diversified investors (VC), traditional share holders (less diversified than VC’s) and Entrepreneurs. Used for getting a range of valuation for the firm across these segments.
  4. Performed three different valuations using three different discount rates

Step Three – sensitivity and stress testing

Performed sensitivity analysis on the following parameters

  1. Discount Rate
  2. Terminal Growth Rate
  3. Average annual revenues per customer
  4. Base Product Penetration rates

Additional analysis was also performed to get a feel for the value of the firm under worst case scenarios and the level of second round funding required.

The four factors were chosen because valuation is very sensitive to changes in anyone of these. Attached exhibits include a list of key assumptions behind the model, projected financial statements, valuation & results of sensitivity analysis.

Key Assumptions for the valuation model

Valuation

  1. Penetration rates have been estimated as the number of people who are classified as early adapters wrt to new products launched by the online education business
Financials
  1. On a net basis, Current Assets would cancel out Current Liabilities. Since the business is subscription based the only significant item affected would be deferred liability.

Market Size

Target Segment

SizeGrowth rate

Number of students per program

300

Stable

Top 50 Business School Students (Past, Present & Future)

285,000

Stable

Number of applicants to the top 50 Business Schools

60,000

Stable

Actuaries & Other certified professionals

233,000

Stable

Small Business Managers (Actual Size = 2 M)

250,000

Stable

Online Investors (Actual Size 2-10 Million)

500,000

20-30%

Stable = zero growth or growing at GDP growth rate

Base Penetration Rates

Target Segment

2000

20001

2002

2003

Top 50 Business School Students (Past, Present & Future)

3%

4%

4%

5%

Number of applicants to the top 50 Business Schools

2%

2%

2%

3%

Actuaries & Other certified professionals

5%

6%

7%

9%

Small Business Managers (Actual Size = 2 M)

0%

2%

2%

2%

Online Investors (Actual Size 2-10 Million)

0%

2%

2%

2%

Discount Rates

InvestorBetaRisk PremiumRisk free rateDiscount Rate
Diversified Investor1.07%6.1%13.1%
Typical investor 2.07%6.1%20.1%
Entrepreneur 4.07%6.1%34.1%

Average Revenues Per customer

The average revenue per customer is a weighted average of the number of customers in a segment time (*) the average revenues for that segment

Market

Average Revenue Per customer

Business school Student Market

50

Business school Applicant market

30

Actuarial Market

175

Small Business Managers

200

Online Investors

250

Average Revenue per customer

175

Expenses

Expenses

2000

2001

2002

2003

Base

Marketing Expenses

15%

20%

25%

30%

% of Net Revenues
Growth in (G & A) Expenses

200%

60%

40%

Increase over last year
Tax Rate

33%

35%

36%

36%

Depreciation Rate

30%

20%

15%

15%

Total Fixed Assets

Valuation Results

Investor Type

Typical Investor

Diversified Investor

Management

Terminal Growth Rate

6%

6%

6%

Discount Rate

20%

13%

34%

Terminal Cash Flow

2,660,359

2,660,359

2,660,359

Terminal Value

18,856,552

37,469,842

9,467,469

PV of Terminal Value

7,543,889

20,247,380

2,183,182

Total Value

13,285,832

26,908,452

6,609,062

No of Shares

1,000,000

1,000,000

1,000,000

Price Per share

13

27

7

Current Offering

50,000

50,000

50,000

Total Expected Proceeds

664,292

1,345,423

330,453

Funding Requirements

RoundAmount% of equityTiming
First round250,000 –300,0002.5%Apr – May 2000
First round250,000 – 300,0002.5%Dec – Jan 2001
Second round1,500,000 – 2,000,000 *Jun – Jul 2001

* Decision for second round financing would be taken in Jan 2001. % of equity would also be set at that stage

Next stage financing would only occur if milestone for earlier stages have been met. Primary reason for using staged financing were

  1. Reduce uncertainty in a systematic fashion at each stage
  2. “Fume dates” to ensure that the team has the right incentives to hit milestones
  3. Retaining management control over the firm

The level of second round funding was determined by analyzing the maximum second year deficit across a range of possible scenarios.

Exhibits for the online education business valuation model

  1. Projected Income Statement
  2. Projected Balance Sheet
  3. Free Cash Flows and Valuation
  4. Scenarios & Results
  5. Sensitivity to Discount rate and Terminal Growth Rate
  6. Sensitivity to Product Penetration and Average Annual Revenues per customer
  7. Sensitivity of Second round funding requirements to Penetration & Average annual revenues per customer
  8. Valuation on Elm Street (worst case scenarios)
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