Despite the end of the IPO boom amid rising interest rates, many investors believed in the prospects of the Russian IPO market. This inspired young companies to raise funding through pre-IPO, the stage preceding a public offering.
LECAP was one of the first companies accredited as a pre-IPO valuation verifier on the MOEX Start platform.
Over the last year we have been approached by more than 10 companies planning pre-IPO, of which 2 projects are in the active stage of realization, and their number will only grow in the future. In addition, our team was able to validate business models for several companies and issue opinions that satisfied both the companies and the market.
We have summarized our approach to validating company valuations and described it in this article.
The Russian IPO market in 2023-2024 has catalyzed companies' interest in raising capital at the pre-IPO stage. Despite the limited number of equity deals at the moment, experts predict their growth in the medium term. As one of the first accredited verifiers of the Moscow Exchange valuation on the MOEX Start platform, our team shares the key aspects of this process.
As a rule, non-public companies choose the income approach using the discounted cash flow method to estimate the value of a company. The DCF method, as it is commonly referred to by professional business appraisers, is based on adding up the discounted free cash flows of a business and determining the terminal value of the company (cash flows in the post-projection period). There are many nuances in the construction of financial models, changes in which can significantly affect the final value of the company, but our post is not about that.
Any business valuation is closely linked to forecasts of revenue and other financial performance of the company, which are traditionally supported by retrospective data. If a company has shown consistent organic growth over a long period in the past, you have every reason to extrapolate that growth into the forecast period.
However, this approach can often be difficult to implement when valuing pre-IPO companies. Potential pre-IPO issuers in the current environment must demonstrate significant business growth in their model for their securities to be competitive in terms of yield compared to bonds or deposits. A number of companies are characterized by explosive business growth over a short period of time due to the withdrawal of foreign competitors from the market, and this redistribution of market share in favor of Russian companies is not fundamentally justified. In such a case, it is necessary to spend a large amount of time analyzing and evaluating the forecast business growth rates to confirm or deny the validity of the issuer's business expansion.
The majority of financial models for pre-IPO projects do not pass our verification due to weaknesses on the part of the issuers or we significantly reduce the expected market value estimate as we accept the responsibility that the Moscow Exchange has placed on us.
It is important to note that a large number of those seeking pre-IPO financing now are companies that have either exhausted debt instruments or do not have the necessary profitability to use debt instruments, which pushes issuers to look for equity capital to reduce the burden on the business. Most pre-IPO offerings take place on investment platforms with low qualification requirements for issuers, which in the long run may lead to a surge of negative cases when “new” shareholders are actually unable to exit the investment because the company does not have the potential for a full-fledged IPO.
Summarizing our short note, we would like to note that the business valuation of a pre-IPO company always has several scenarios defining the corridor of possible market value. However, in order for the pre-IPO market to remain in demand among investors and not to be destroyed by several failed offerings, we believe that such valuation should be conducted with all possible scrupulousness, based on conservative business growth forecasts.
Although we are cautious about confirming the market value of potential issuers' businesses, our team has been able to confirm for several companies their business models and issue opinions that have satisfied both the companies and the market.