Venture capital method
Description of the Venture capital method and its use cases
The Venture Capital ('VC') Method works its way to pre-money valuation after first determining the post-money valuation using industry metrics. By applying the VC Method to solve for the pre-money valuation of a startup it's important to know the following equations:
- Post-money valuation = Terminal value ¸ Expected Return on Investment (ROI)
- Pre-money valuation = Post-money valuation + Investment
We will use these formulas to ultimately work out the pre-money valuation, but first we need to find the terminal value. We determine the value of the company at the time of exit by multiplying the sales forecast in the exit year by an industry-specific sales multiple. The terminal value is the anticipated value of an asset on a certain date in the future. The typical projection period is between four to seven years. Due to the time value of money the terminal value must be translated into present value to be meaningful.
The venture capital method is most commonly used in the venture capital industry and for valuing startup ventures. Investors will seek a return equal to some multiple of their initial investment or will seek to achieve a specific internal rate of return based upon the level of risk they perceive in the venture.