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Valuing Early Stage and Venture-Backed Companies



Valuing Early Stage and Venture-Backed Companies

Neil J. Beaton

ISBN: 978-0-470-60276-8 February 2010 224 Pages



Find out what your early stage business is really worth—and what you can do to increase its value even more

One of the most misconstrued concepts in business today, valuation has also rapidly become one of the most important for business owners in today's unpredictable financial atmosphere.

An experiential and practical guide drawn from author and valuation expert Neil Beaton's fifteen years of focused start-up work, Valuing Early Stage and Venture-Backed Companies equips you with a solid foundation of the ins and outs of early stage and venture-backed valuations—no matter what your field.

This step-by-step guide offers contributions from top valuation practitioners, walking you through:

  • New techniques for applying options methods

  • The pros and cons of the option pricing model

  • Early stage preferred stock rights

  • Applicable discounts for early stage companies

  • New procedures for implementing the probability-weighted expected returns method

  • Valuation theory, the consensus view on application, and the tools to apply them

  • The popular and widely used AICPA Practice Aid, Valuation of Privately-Held Company Equity Securities Issued as Compensation

Valuing Early Stage and Venture-Backed Companies replaces bewildering computations with technical expertise to help you figure out what your business is really worth, and how you can increase that value starting today.

Preface ix

Acknowledgments xi

About the Author xiii

CHAPTER 1 Laying the Foundation 1

A Unique Landscape 1

An Overview of the Venture Capital Industry 8

Conclusion 14

CHAPTER 2 Understanding Early Stage Preferred Stock Rights 17

Stock Rights 19

Contractual Rights 28

Conclusion 32

CHAPTER 3 Enterprise Valuation Approaches 35

Relevancy of Traditional Valuation Approaches 35

Cost Approach 40

Market Approach 43

Income Approach 45

“Vectoring” Valuation Approach 46

The Income Approach as an Oxymoron 53

Conclusion 58

CHAPTER 4 Application of the Option-Pricing Method in Allocating Enterprise Value 59

Important Assumptions Underlying the Option-Pricing Model 61

Option-Pricing Method Steps in Application 66

Other Considerations in the Option-Pricing Method 86

Pros and Cons of the Option-Pricing Model 87

Conclusion 88

CHAPTER 5 Application of the Probability-Weighted Expected Returns Method in Allocating Enterprise Value 89

Illustration of the PWERM 90

PWERM Critical Assumptions 94

Overview of Stock Rights 96

Identification of Outcomes 98

Updating PWERM Analyses 104

Conclusion 105

CHAPTER 6 Applicable Discounts for Early Stage Companies 107

Basis of Discounts 108

Suggested “Corrections” to the Current Use of Put Models for Quantifying DLOMs 114

Dilution Discount 119

The Likelihood of Liquidity 120

Conclusion 123

CHAPTER 7 Advanced Valuation Topics for Early Stage Companies 125

Utilizing the OPM as a “Valuation” Methodology 127

Sequential and Compound Options 127

Allocating the Residual Value 131

Further Extensions for Compound Options 137

Venture Capital Rates of Return 139

Executive Stock Compensation 143

Conclusion 143

APPENDIX A Allocation of Enterprise Value Using the Option-Pricing Method: Treatment of Derivatives on Common Stock 145

APPENDIX B Volatility in the Option-Pricing Model 155

Notes 175

Index 179