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seedinvestor


Total Posts: 3
Joined: Aug 2020
 
Posted: 2020-08-21 09:08
Hey guys, longtime lurker here with a question on valuing a startup trading firm.

I have an opportunity to invest seed capital in a startup trading firm training a machine learning AI to generate leading trading signals with a focus on US equities. Looking past the overused buzz words... let's assume the signal generation works well enough in backtesting to roll out in production.

The exact business model is not determined yet but so far ideas have been to license access for a fee and/or profit share agreement, trade on the signal ourselves using proprietary capital, maybe a blend of both.

The founders currently value the firm at $6M. I asked how they arrived at a this valuation and was told they compared themselves to other early stage startup trading firms. Honestly, I'm not sure where they could have found that information? Every trading firm I've worked at has been private.

Thoughts?
Thanks!

svisstack


Total Posts: 355
Joined: Feb 2014
 
Posted: 2020-08-21 09:54
you can find information about the fundraising of private companies in the public, they probably compared themselves to valuation at round performed by the competition, but you should ask them of course

First Commander of the USS Enterprise

prikolno


Total Posts: 67
Joined: Jul 2018
 
Posted: 2020-08-21 22:14
For seed stage valuation of a ML-styled trading firm these days, probably market reference is taking 25-50% for a total raise of 2 senior + 2 junior persons' salaries and operating expenses with 18-24 months runway. Adjust this for pedigree, results, liquidity modifiers in your favor, and/or amount of risk they're taking themselves. If you think this produces an expensive valuation (i.e. their requested salaries and infra expenses are very high) or they need more runway, then chances are the offer is just overpriced.

$6M is fairly high in my opinion... I went through the process myself and my firm had a lot more traction than you're describing before it breached that.

This heuristic is also easier to use since it's relatively simple to determine market rates for compensation and infrastructure expenses, while it is hard to find comparables for private valuations of trading firms. It's also intrinsically closer to how it actually works as a business... Many who've only worked on the employee side are dazzled by the seeming complexity of the technology in front of them and scoff at me when I tell them that quantitative trading firms resemble a recruiting business asymptotically, but they really do... (It's bad taste for someone with a hard-earned PhD from a top 20 university to be told that they're just working for an advanced recruiting firm...) I'm being pessimistic and overgeneralizing here, but you're not investing in the current iteration of the strategy or infrastructure, but their ability to retain and incentivize talent despite highly asymmetric payout in favor of the founders, and their ability to deter duplicate efforts by design of the strategy or management policy - just like how recruiters try to make you sign an exclusive deal.

They trade off connectivity, infra and bulk clearing/exchange fees for a bigger cut and managerial autonomy - it's not like they'll get a much better payout for a similar PM deal with firms whose names start with M, T, E, J or P.

0.9-1.2x LTM is quite standard for wholesalers, FX market makers, dealers with several years under their belt.

In the absence of revenue, you could make your own guess of what future revenues are in Y1, Y2, ... and then discount them by risk that it just outright fails and do a DCF, and take a weighted average of this estimate with comparables.

seedinvestor


Total Posts: 3
Joined: Aug 2020
 
Posted: 2020-08-22 15:42
So much value in this response, thank you. FWIW, neither of the founders are taking a salary at present.

I'm going to give your response some more thought as I ponder this investment. I absolutely agree $6M is too high though.

gamerx


Total Posts: 19
Joined: Sep 2012
 
Posted: 2020-08-23 02:45
How would one even go about estimating their future revenue though? These people are in the business of selling signals not trading if I understood OP correctly.

seedinvestor


Total Posts: 3
Joined: Aug 2020
 
Posted: 2020-08-23 12:18
Good question. The business model is not agreed upon yet and could take the form of signal selling/licensing, subscription access to the platform or even just trading our own proprietary capital using the signal.

apurvabajaj


Total Posts: 2
Joined: Aug 2020
 
Posted: 2020-08-27 12:28
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