[Valuations] Human vs ChatGPT
May 30, 2023
Who won round one of the human vs AI valuations battle?
My marketing team suggested that I have a go at using ChatGPT to write this email.
I had a few goes and most of the responses were not that exciting.
But I eventually hit on something.
This is what I asked and what it replied.
(Keep reading and I’ll give you my assessment of just how good AI is).
PROMPT: Explain how a private company’s value can rise and fall suddenly and then rise again
ChatGPT responded:
The value of a private company can experience sudden fluctuations due to various factors that impact its financial performance, market conditions, and investor sentiment.
These fluctuations can be attributed to both internal and external factors, and understanding them is crucial in evaluating the company’s potential for sudden rises and falls in value.
- Internal Factors:
Financial Performance:
A private company’s value is closely tied to its financial performance, including revenue growth, profitability, and cash flow.
If the company experiences a sudden surge in sales, successfully introduces a new product or service, or improves its operational efficiency, its value may rise abruptly.
Conversely, a significant decline in sales, financial mismanagement, or operational challenges can cause the company’s value to plummet.
Management and Leadership:
Strong and effective leadership plays a vital role in a company’s success.
A sudden change in management, such as the appointment of a highly regarded executive or the departure of key leaders, can impact investor confidence and consequently affect the company’s value.
Competent management that demonstrates sound strategic decision-making and adaptability can help restore the company’s value.
- External Factors:
Market Conditions:
Economic factors, industry trends, and market dynamics can influence a private company’s value.
For instance, during periods of economic growth, investor optimism may drive up the value of companies across various sectors.
Conversely, economic recessions or industry-specific challenges can cause a sudden decline in company valuations.
External factors such as regulatory changes, geopolitical events, or technological disruptions can also impact a company’s value.
Investor Sentiment:
Investor perception and sentiment can have a significant impact on a company’s value.
Positive news, favourable market sentiment, or an influx of new investors can create sudden spikes in valuation.
Conversely, negative news, investor scepticism, or changes in market sentiment can cause a sharp decline in value.
Perception and sentiment can change rapidly, leading to sudden fluctuations in a company’s value.
Mergers and Acquisitions:
The announcement of a potential merger, acquisition, or strategic partnership can significantly impact a company’s value.
Positive news regarding a potential deal or a significant investment can lead to an immediate rise in valuation.
Conversely, the failure of a major deal or uncertainty surrounding acquisition plans can cause the value to decline.
Successful completion of mergers or acquisitions can potentially drive the company’s value up again.
It is important to note that sudden rises and falls in a private company’s value can occur due to a combination of these factors, often intertwined with each other.
Additionally, investor perception and market sentiment can sometimes lead to an overreaction, causing extreme fluctuations in value that may later correct themselves as more information becomes available.
Overall, understanding the factors that influence a private company’s value and closely monitoring both internal and external factors can help investors and stakeholders anticipate sudden fluctuations and make informed decisions to navigate these dynamics successfully.
What do you think?
It so happens that we’ve just completed a valuation of a company which bore these characteristics and I wanted to tell you about it.
The ChatGPT answer did not do quite enough for me to believe that reading this email without my own analysis too, would be a valuable use of your time.
This is how I would describe the case:
The background:
An exciting tech company raised from angels at a very high valuation last year (when the market was still toppy) and is looking to raise at a 10x higher valuation soon.
There is a term sheet with an offer at the 10x higher valuation.
To give you an idea. we are talking £ms and £10ms for the respective rounds. In between the funding rounds some of the original shareholdings must change hands to sort out a previous injustice in share issuance.
Neither party has the cash to pay the tax liabilities that could fall due if the transaction valuation is “too high”.
But if the transaction does not go ahead, crucial members of the team will walk away from the business and the business will collapse, with the result that all value in the equity will be destroyed.
Tricky eh?
ChatGPT did pick up the key issues that we considered.
We did look at financial performance of the underlying company.
In this case there were no sales yet, lots of expenditure on R&D but nothing tangible had yet been created, although the hope still existed that one day something would.
What is the value of the company with that financial profile in a real-world scenario?
From a tax perspective would a prudent investor be willing to pay anything for shares in such a company today?
The team issue was obviously critical.
It was made clear to us that the team would walk away if the transaction did not happen.
Without the team the business would be valueless and there would be no team if the transaction could not complete.
That was clearly a reason why any value in the equity in the business was significantly denuded until the transaction had taken place.
We also considered market conditions.
It was clear that whilst some high-risk speculative investors are still placing extraordinary valuations on some start-ups with explosive potential, those investors are now few and far between.
Many of the highest risk appetite investors in the UK are currently holding back on making new investments.
Fund managers are struggling to raise capital and capacity (regardless of desire) is holding back the volume of money that is available to exciting start-ups.
In any case the shares underlying the transaction were not being offered to new investors. The transaction envisaged was a secondary transaction between a handful of people only, not a new share issuance.
This was another good reason to rethink the prima facie value of the shares.
The crash in tech VC valuations has been well documented and whilst the US data trends, now emerging suggest things may start looking up in the UK later this year, at the time of the valuation, the sentiment was pretty gloomy.
The general state of the UK economy worked in favour of a considered view that it was pretty dark for the company we were valuing.
Of course we considered a lot more factors, but we kept coming to the same conclusion. At the date of valuation and in the context of HMRC valuation rules (as opposed to IPEV valuation rules), the shares in company really did not have much value at all.
In reality, it was a small company with nothing to sell, with a core team vulnerable to departure, operating in a weak economy with inflation biting.
The cash on the balance was worth its face value of course, but its equity value really was de minimis.
If you have a knotty situation where getting the value of shares for a transaction right is critical, we can help, especially with evidence based arguments that will stand up to challenge.
Just give me a buzz on 07736 676 212 or email me at modwenna.rees-mogg@athlacapitalmanagement.com.
And regarding ChatGPT or other generative AI as a useful mechanism for emails (and certainly for creating the arguments needed to value a business such that the valuation is hard to challenge), personally I do not yet think it is yet the answer.
I am going to keep going though.
Generative AI will mature and all of us need to work with it rather than run from it.
