For
an early stage company, valuation (or company worth) is not driven by
present profits but by growth i.e. expected future profits
The valuation of any company is driven by three parameters:
- Free cash flows (Profits + other activities that generate cash)
- Capital Structure and Cost of Capital
- Expected Growth
A clear understanding of the venture capital industry will
tell you that the high valuation of an early stage company is being
driven expected growth, and not the present cash flows (or profits).
What
this means is that the expectation is that the company will generate
huge profits in the future, so essentially investors are buying a pie of
these future cash flows today. The expectation that VC investors have
of e-commerce players like Snapdeal and Flipkart is that they will have
huge demand in the future and will simultaneously also be very
profitable. This is precisely the reason why valuation is not only a
science, but also an art, as it depends a lot upon what you "feel" is
the future of a business.
Why do they buy
cash flows today? Buying cash flows today is "cheaper" than buying these
cash flows later, because they are taking a bet on the company's
future. Taking a bet will require a taking a risk,
which is essentially why it is cheaper, as you should get some
advantage over someone who will not be taking that risk later when the
company is actually profitable. How do you "buy" cash flows? Equity. If
an investor buys equity, let's pays 10 million for 10%, the value of the
company becomes (10/0.1) = 100 million. As the founders have an equity
stake in the company because they have founded it, billion dollar
company founders also become billionaires.
The Bansal's hold around 7.5% of Flipkart each, which makes them valued at 1.5 billion$. Kunal Bahl at Snapdeal is not a billionaire yet, he would be worth around 400 million $.
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