Doing “Deals”: Investment vs Valuation in Vietnam

Recently, I’ve seen some pretty sensational stories on start-up blogs, news, and events.  Some of these stories may come from a simple misunderstanding about the terms and mechanics of early stage investment and valuation in Vietnam. So my goal with this post is to help demystify some basic concepts and terms used in entrepreneurial finance.

Let’s take a hypothetical situation.  Let’s say you’re an e-commerce startup in Vietnam, you’ve gotten some traction in the market through a group-buying model, and now you want to leverage your resources into a full-fledged e-commerce retailer.  If you, the entrepreneur, say to a reporter who may be unfamiliar with entrepreneurial finance, “We just closed a $60 million dollar deal…” this can mean one of two things: 1) You received $60 million dollars in financing, or 2) The total value of your company after the investment was made (referred to as the post-money valuation) is $60 million.

In scenario 1, $60 million invested would imply a total valuation of $120-300 million, depending on how much equity was exchanged for $60 million. (This could be anywhere from 20-50%, venture capitalists would typically take a 33% stake, so we could estimate a total post-money valuation of $180mil).

In scenario 2, a $60 million valuation would imply a much smaller cash investment, anywhere from $12-30 million, again depending on what percentage of equity the investors purchased.  (The typical range is from 20-50%, with 35% being average, so we could estimate 33% which would put cash investment at $18mil).

The table below shows the two scenarios, assuming the investors took a 33% equity stake in the company.

	Case 1	Case 2
Investment	$60 million	$18 million
Valuation	$180 million	$60 million

In real terms, this is a difference in available cash that you can spend growing your business of $42 million dollars.  For a new company, and especially an e-commerce start-up focused entirely on the Vietnam market, a $60 million dollar investment seems a bit out of place.  As a point of comparison, Mekong Capital invested $3.5mil in a mobile handset retailer (The Gioi Di Dong) at a total valuation of $10mil.

In terms of the valuation of the company itself, venture capital investors typically expect a 20-35 times the return on their investment within 5 years.  So the company in Case 1 would need to reach a total valuation of at least $3.6 billion in the next 5 years.  In Case 2, the company would need to be worth at least $1.2 billion.  While the ideal timeframe for an exit is 5 years, many companies take up to 10 years or more to have an exit (through M&A or IPO), and this only makes the required exit value higher for the company.

As another point of comparison, last year Flipkart.com, one of the dominant e-commerce companies in India, received an investment that valued the company at $850 million.  The company has been in operation since 2007, and has projected revenues for 2012 of $97 million. Assuming a 10% net profit margin, and a Price to Earnings ratio of about 10x, the $850 million valuation seems pretty reasonable.

So what would be a reasonable valuation for a Vietnamese e-commerce start-up?  Since there aren’t any published statistics about the Vietnam e-commerce space, let’s compare some basic demographic data about India and Vietnam.  India has about 11 times the population and 16 times the GDP of Vietnam.

So, the key question here is, would a $60 million dollar investment make sense for a Vietnam-focused E-Commerce company?  Or would a valuation of $60 million be more reasonable?  If you were an investor, how much would you invest, and what could you reasonably expect to get back in the future?

For a more in-depth look at current trends in early stage investing, check out the book “Early Exits” by Basil Peters (http://www.early-exits.com/).

Image by Flickr user toehk (Creative Commons)