Module II· DCF — Mechanics & FCFAdvanced
Question
How do you model a growth company with negative FCFs in the early years (e.g. a pre-profitability SaaS)?
Answer
Negative FCFs are not a DCF killer — they reflect a real investment phase.
Mechanics
Negative FCFs are discounted at the WACC and make a negative contribution to EV. Three points are decisive:
- A long enough horizon: the company must reach BOTH profitability AND a steady state, often Year 8–12 rather than 5 for pre-profitability targets.
- Margin trajectory: model an S-curve path, e.g. −10% today, +5% in Year 5, +20% in Year 10. Capex intensity falls with maturity.
- Funding gap: can the company finance the negative FCFs? If not, you need dilution assumptions or a debt burnout.
Many software companies have historically gone through exactly this shift from negative FCFs to high profitability — the DCF needs a long horizon to capture it.