The Art and Science of Valuation

A few weeks ago, at The Information’s Creator Economy Summit, Kaya Yurieff asked Hank Green if Mr. Beast’s reported $1.5Bn valuation was warranted. Without skipping a beat, Hank responded “yes.” Perhaps his conviction stemmed from an analytical deep dive into the Beast empire, or maybe from a strong gut instinct. Which approach is right? The answer is… both.

Valuing any business is equal parts art and science – just ask any junior investment banker. No matter how many hours are spent painstakingly building a model, senior bankers find a way to tweak inputs and projections until the price per share feels right relative to the market and, most importantly, is in line with client expectations. Magic.

As a rule of thumb, the earlier the venture, the more art is involved. Seed investors often deploy capital in the earliest days, when new “companies” are simply founders with an idea. Typically, a deal is struck on a SAFE at or below a valuation in the low- to mid-teens ($M) – but the exact “price” is largely determined by what someone is willing to pay. This balance shifts much more towards science as the company matures and more data becomes available.

Backing creators is a natural extension of seed investing – and though you are technically investing even earlier, creators, ironically, provide more to “value” than most early-stage companies. Unlike many seed-stage businesses, creators are earning real cash flow and more closely resemble SMBs. In many cases, the creator may have launched a business in a category familiar to traditional capital markets, making it easy to benchmark valuations to a competitive set. Consequently, we can draw on traditional valuation methodologies to perform a sum-of-the-parts (“SOTP”) exercise for a creator holding company. Let’s dive in:

Discounted cash flow (“DCF”). DCF’s are rarely, if ever, used in venture capital because most venture-backed companies, well…lack the “CF”. Creators, however, often earn material revenue from brand deals, sponsorships, and AdSense; this revenue tends to be high margin, as it is largely unencumbered by expenses. With a decent sense of earnings magnitude and margin, we can run a DCF using cash earned from content. Working closely with the creator and their team, we can develop several scenarios and apply a probability to each, effectively sensitizing the growth rate of cash flow over a period of time. We use this method to better understand the dollar amount an investor might receive in any given year, after the creator has surpassed their income threshold. (Note: net revenue and income threshold are deal points worked out between the parties).

Market comparables. For creators who have built businesses in categories such as commerce, media, or sports, etc., we can use data from precedent transactions of similar companies to understand their value. This information may come from prior financing rounds or acquisitions, and it provides a useful market basis for comparison. Fortunately, there is an abundance of data available, usually around comparable revenue multiples, such that we can confidently determine an appropriate value range. If the creator only has a percent stake in the business, only their ownership should be accounted for.

Venture premium. When we back a creator’s holding company, we are making the bet that they will generate future enterprise value tied to creator-related businesses or activities that don’t yet exist. In order to compensate for new ventures created in the future, we apply a premium to our SOTP valuation. Admittedly, this component is the most “art-based” of the valuation exercise and depends on the complexion of the creator’s category, business lines, and competencies.

The most critical piece of the valuation exercise is undoubtedly working with the creator and their team to understand their business and its present and future growth levers – that is, the business in its steady-state and how capital may impact its expansion. We believe our approach serves as a sound bedrock for deal structuring, as it helps both parties assess and agree on the potential future value of the holding company. We’ve discovered it also encourages the creator to think critically about their business, their goals, and the work required to get there. As we continue to invest in creators and collaborate with their talented teams, we are excited to refine our approach and see our valuation methodology mature.

Editor’s note: For brevity, we’ve assumed our readers are relatively familiar with the valuation methodologies discussed above; however, it is important to remember that each methodology depends on various assumptions and therefore, yields a range of outcomes.