710  High-Growth Companies ­estimates, because this approach implies precision that doesn’t exist and obscures the key uncertainties that could improve decision making. Keep in mind that while scenario-based DCF techniques can help bound and quantify uncertainty, they will not make it disappear. High-growth com- panies have volatile stock prices for sound reasons. A Valuation Process for High-Growth Companies When valuing an established company, the first step is to analyze historical performance. But in the case of a high-growth company, historical financial results provide limited clues about future prospects. Therefore, begin with the future, not with the past. Focus on sizing the potential market, estimat- ing the share of the market the company will capture, predicting the level of sustainable operating margin, and approximating the investments necessary to achieve scale. To make these estimates, choose a point well into the future at a time when the company’s financial performance is likely to stabilize, and begin forecasting. Once you have developed a long-term future view, work backward to link the future to current performance. Current performance measured using ac- counting statements will mix together investments and expenses. When pos- sible, capitalize hidden investments, even those expensed under traditional accounting rules.3 This is challenging, as the distinction between investment and expense is often unobservable and subjective. Given the uncertainty associated with high-growth companies, do not rely on a single long-term forecast. Describe the market’s development in terms of multiple scenarios, including total size, likely competitive structure, and so on. When you build a comprehensive scenario, be sure all forecasts, in- cluding revenue growth, profitability margins, and required investment, are consistent with the underlying assumptions of the particular scenario. Apply probabilistic weights to each scenario, using weights that are consistent with long-term historical evidence on corporate growth. As we saw during the dot- com bubble of the late 1990s, valuations that rely on unrealistic assessments can lead to overestimates of value, poor investment returns, and strategic errors. Start from the Future Begin by thinking about what the industry and company might look like as the company evolves from its current high-growth, uncertain condition to a 3 Chapter 24 presents a methodology for capitalizing intangible expenses, such as research and development. A Valuation Process for High-Growth Companies  711 state of sustainable, moderate growth in the future. Then interpolate back to current performance. The future state should be defined and bounded by mea- sures of operating performance, such as customer penetration rates, average revenue per customer, and sustainable margins. Next, determine how long growth will continue at an elevated rate before it stabilizes to normal levels. Since most high-growth companies are start-ups, stable economics probably lie at least 10 to 15 years in the future. To demonstrate the valuation process for high-growth companies, we ex- amine Farfetch, a popular online marketplace for luxury goods. Founded in 2007 by José Neves, Farfetch was conceived in response to the founder’s own struggles to transition from an in-store boutique to a web-based e-tailer. Neves believed that local boutiques lacked the skills and scale to successfully migrate the transition to digital on their own. Farfetch would fill this gap. The company launched its website in 2008, selling luxury products from 25 boutiques in five countries. Over the next decade, the company raised nearly $700 million in private capital, growing revenue to more than $600 million by 2018. As Exhibit 36.1 demonstrates, the company has grown at more than 50 percent in each of the last three years. This level of growth significantly outpaces the growth at more established technology-enabled marketplaces. To estimate the size of a potential market, start by assessing how the com- pany fulfills a customer need. Then determine how the company generates EXHIBIT 36.1  Farfetch: Revenues, 2015–2018 $ million 2015 142.3 2016 242.1 Compound annual growth rate = 62% 2017 386.0 2018 Growth, %   70 59 56 602.4 Source: Farfetch F-1 filing and 2018 20-F filing.