Valuing start-ups mainly on scorecards

 

I came across this simple visual on the different methods for valuing start-up firms, and found that it does not follow a set format. Of the five methodologies, only one is based on DCF, a second is based on industry multiples, and the other three are focused on a scorecard. 

Should it be surprising that when assessing start-up companies, the focus is not on cash flow projections but on a narrative based on rankings? There is no clear idea for how to handicap or calculate risk, so there is a focus on creating characteristic rankings to form an overall ranking of potential success. 

When faced with uncertainty, other methods of analysis are needed to form a risk assessment. In this case, factor scorecards have been developed to solve the problem. 

Risk is not uncertainty

“For uncertain matters there are no calculable probabilities whatsoever. We simply do not know.” -Keynes 

As we move into the new year, we hear projections about what will happen in 2026. It is a fool's errand. These projections are often not grounded in risk assessments, which are countable and measurable. They are framed in narratives. More importantly, they are focused on uncertainty, which means there are no calculable probabilities. Some have defined this as radical uncertainty, but we do not need the adjective. We just do not know the likelihoods, and in most cases, the analysts of these forecasts will not provide probabilities. They are just stories and should be viewed as such. 

Exiting at the wrong time - the key investor mistake

Hat tip to Andrew Breer for highlighting this interesting chart of the Man AHL UCITs fund. Notice that money flows out of the fund on the drawdown, and it does not match when the performance turns around. This has been an age-old issue with CTA, but it also applies to many fund investments. Investors lose money and exit the fund, only to see performance turn around and miss the reversal. This seems odd, especially for managed futures, because trading odds are active and go both long and short. Hence, there can be losses, but positions may be cleared out and new positions established that are opposite to the prior risks taken. 

You are buying a system, not a particular investment. If you exit, it is because you no longer believe the methodology can produce position returns. We have learned that trend and momentum do generate long-term returns; however, there will be periods of underperformance. Investors have either been long-term holders or are willing to actively trade their positions, entering or increasing positions during drawdowns. 

There needs to be more research on the decision-making of investor and why or when they exit investments. 

Themes drive the big returns in equities

Themes drive investment returns, or, put differently, key narratives drive significant returns during a market cycle. Unfortunately, themes do not last, and themes can turn into bubbles. If you don't exit one of these considerable themes, you will eventually be disappointed. Each of the themes listed above reverted to normal, so the key investment decision is to know when a theme develops and when it has reached an extreme. Wall Street spends significant time identifying these themes and then sells them to others. They make money when investors transition between themes as capital is redeployed.