Note on Valuation in Venture Capital HBS

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Valuation for Venture Capital
The determination of the value of a company before investing into is a blistering challenge for venture capitalists. There exist various arbitrary methodologies of valuing a company such as net present value and comparables. However, these methods retain loopholes in valuating private companies. These companies rarely have substantial or consistent operating histories to base their forecasts of revenues in the process of valuation. Innovating companies offer more promise than generic companies in such a case do. Frequently, the subjective and optimistic view of entrepreneurs might cloud the actual value of a company. However, venture capitalists will always go the cheapest way to maximize their returns.
Using comparables, industry values that appraise similar companies, are of significance in determining the value of a company. The price/earnings, total enterprise value/EBITDA or enterprise/revenue ratios are crucial in this methodology (Richard Ivey School of Business 4). These comparables match a company to the categorization of its industry, size, cost structure, growth rates, distribution strategies, profit prospects and other metrics that determine its performance. Comparable variables are obtained from values of publicly traded companies, related acquired private companies and looking at recent history of similar investments. This methodology works best as all available metrics are used to hedge against errors of analysis.

Allternatively, net present value uses the cash flows, discount rates and terminal value in determining the future financial position of a company (Richard Ivey School of Business 9). For a venture capitalist, this presents significant uncertainty as the cash flows rarely match up to the forecasted values. A high discount rate in the valuation process counters this wide margin of error.
For a Stage A company that is pre-cash flow, determining the comparables at Stage B, for example, the consumer base and existing strengths. Alternatively, sharing the load 50/50 or bridge building could justify the high risk of such an investment (Richard Ivey School of Business 12).
Conclusively, the process of valuation should maintain its accuracy for the benefit of involved parties. The risk analysis, replicability of the valuation process and justification of successive rounds of investment based on performance assure the venture capitalist on their investment.

Works Cited
Richard Ivey School of Business. A Note on Valuation for Venture Capital. The University of Western Ontario.