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4.3 Lifecycle Phases

This section discusses the second pillar of PECCS, the lifecycle phase of a private company. We explain why lifecycle phases are important for private companies and the implications of their phase on the characteristics of a private company. We then explain our approach to categorising private companies into each of the proposed classes, based on objective guidelines.

Motivation For Considering Lifecycle as a Pillar

A key dimension of the valuation of private companies is their lifecycle phase. Compared with public companies, the lifecycle phases of private companies are often more heterogeneous (e.g., younger companies are usually investable in private markets much before they are ready to publicly list), thus making it a key systematic risk factor. For example, the systematic risks faced by portfolio companies within a venture capital fund is different from those faced by holdings of buyout funds. Despite the recommended guidelines to classify private companies, data paucity issues may hinder assigning companies to classes, and in such cases, qualitative information about the company can help in finding its relevant class.

Typically, the lifecycle phase of a company has implications for strategy, growth, operations, and investments (Forbes, 2018). Different lifecycle phases of business development are themselves the outcome of the changes in the strategy, structure, decision-making methods, and organisational situation of firms (Miller and Friesen, 1984; Su et al., 2017). Prior academic work typically propose five phases a typical company experiences, namely birth, growth, maturity, revival, and decline. The birth phase is characterised by small, young firms, which are dominated by owner-managers and unlikely to seek external capital, especially from institutions. The companies are also homogeneous and born out of creativity (Greiner, 1998). Moreover, governments also spur innovation and entrepreneurship in the economy, by specifically targeting young and small firms for tax, R&D, and productivity related programs that offer various incentives, subsidies, or tax reliefs. The growth phase follows when the firms are older, investable, have multiple shareholders, operate in a competitive environment, are likely EBITDA positive, and witness rapid growth (e.g., Lyden, 1975).

The maturity phase is an extension of the growth phase where firms are even older, more dispersedly owned, and operate in more competitive environments. In this stage, firms are also more formal and bureaucratic, and offer differentiated products or services. This phase is followed by the revival phase at which the firms reach their maximum size and operate in dynamic and extremely competitive environments. Firms strive to diversify into different industries or products/services at this stage. The final phase is decline where firms stop innovating, lose market share, and do not use very sophisticated decision-making processes (e.g., Scott, 1975).

Although these theoretical phases characterise most companies at different stages with implications for investors, the challenge is in the blurred demarcation between each of these phases, and the difficulty in assigning companies to a phase in the cross-section. To achieve a meaningful segmentation, the principles of these phases are combined with quite commonly available information about private companies such as their most recent financing or reorganising decision to come up with the below classes. These classes are relevant and familiar to industry practitioners.

The categories include:

  1. Startup: Further subdivided into Early Stage, Late Stage, and R&D Ventures subclasses.

  2. Growth

  3. Maturity: Further subdivided into Conventional Mature, Reorganisation, and Restructuring subclasses.

Implication of Lifecycle on Valuation

These three distinct classes have different implications for the valuations and return expectations of investors. For example, when looking at startup companies, investors are less likely to rely on historical financial information but rather evaluate companies on the creativity of their business and the problem that the company solves in the marketplace.

However, in a growth asset, investors expect higher top-line growth but without an accompanying expansion in net profits, although they may be EBITDA positive. Investors are tolerant of lower net profitability as a trade-off for higher growth.

In a mature company, however, preferences invert for investors and they prioritise profitability. At this stage, more focus is on operating efficiency and capital structure decisions which can provide a large fraction of the returns to investors.

Lifecycle Classification Guidelines

Having established the categories, the next step is to formulate rules to assign private companies (or specifically private company-years) to each of these different stages.

A simple assignment based on the age of the company can be misleading as not all companies are born equal. For example, companies created through divestitures, carveouts, or spin-offs already operate in a mature phase but are young. Thus, additional information is required to classify the companies. An approach that looks at both qualitative and quantitative information to assign company-years to lifecycle phase is favoured. Such an approach can take into account the recent financing rounds, reason for company formation (e.g., divestitures), capital structure information, disclosure levels, age, and the rate of sales growth.

Table 3 lays out the principles behind the classification of a private company according to its lifecycle phase pillar of PECCS. These principles apply for most firms with the exception of highly innovative companies that may operate permanently in startup modes, e.g., a R&D organisation that is developing new pharma formulations.

LP Subclass Code

LP Class Name

LP Subclass Name

Description

LP01001

Startup

Early Stage

i) Any company that is 3 years or younger, and whose formation is not the result of divestiture, spin-off, split-off, or a carve out.

ii) Includes companies that have obtained seed-round or early-stage financing (e.g., Series A) in current or previous year. Seed round funding is the first round of offering ownership to outside investors other than the founding team, and the product or service is only an idea. Early-stage financing follows seed stage, and this is when the company has a working prototype of the product or service. 

LP01002

Startup

Late Stage

i) Any company that is between 3 and 7 years old and whose formation is not the result of a divestiture, spin-off, split-off, or a carve-out is to be considered as a late stage company.

ii) Includes companies generating revenue and have obtained multiple rounds of financing (e.g., Series B, C, or later) in current or previous years

iii) Companies that are less than 15 years in age, are generating revenue, but still are unprofitable are also included here, provided they do not qualify under any Growth class criteria.

iv) Companies that are less than 15 years in age, and have recently (i.e., in the previous three years) raised capital from a venture-capital fund.

LP01003

Startup

R&D Ventures

i) Companies that solely engage in clinical trials or product development, irrespective of their age, are included here.

ii) Companies that do not qualify for any other Startup class, but are eligible for targeted tax, R&D, or productivity related programs that offer incentives, subsidies, co-investments, or tax reliefs. Exclude considering programs that are available to all companies.

LP02001

Growth

Conventional Growth

i) Any company that is between 7 and 15 years old, and whose formation is not the result of a divestiture, spin-off, or a carve out is included as a growth company. 

ii) Any company that is over 7 years old and has recently (i.e., up to three years in the past) obtained financing that can be characterized as Growth or Expansion financing, is included here.

LP03001

Mature

Conventional Mature

i) Any company that cannot be classified as Growth or Startup and is older than 20 years old is considered mature.

ii) Any company that is between 16 and 20 years old, and has been owned by a Private Equity firm or has been part of a general partner-led secondary buyout transaction is included in this class.

iii) Any company that is between 16 and 20 years old, and has been part of at least one recapitalization can be considered as mature.

iv) Includes companies in mass adoption stage or in saturated markets. Mass adoption stage is where their products and services are offered in a growing market, while they themselves are mature. Saturated markets are when the demand for their products or services has plateaued.

LP03002

Mature

Reorganization

i) Any company that is formed through divestitures (or spin-offs, split-offs, carve-outs) from old and established corporations, irrespective of their age, are included here.

LP03003

Mature

Restructuring

i) Companies that are in bankruptcy or some form of reorganization are included here,

ii) Includes companies that are pre-bankruptcies. Pre-bankruptcy includes companies that have made a filing for reorganization or have missed one or more debt payments.

iii) Includes companies that are post-bankruptcy. Post-bankruptcy includes companies that have already emerged from bankruptcy and have restructured creditor claims. 

Table 3: Lifecycle Phase Subclasses

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