Venture Capital Valuation: Case Studies and Methodology

December 2011 Hardcover (288 pages)

Lorenzo Carver

John Wiley & Sons, Inc.

When founders, VCs, angels, attorneys, CFOs, CEOs, and employees don't understand the true meanings of "value" and "valuation," they end up losing money—lots of money. Venture Capital Valuation is for anyone involved in a venture capital- or angel-backed private company who wants to get the most out of their investments by controlling one of the few things they can when dealing with high-velocity, risky investments: their understanding of valuation.

Author Lorenzo Carver shares his decades of experience simplifying the high-growth company valuation process for clients in every business sector. Anchored by scores of high-profile examples, Venture Capital Valuation deftly illustrates how stakeholders in a given startup or high-growth company could have improved their outcomes by having better information about valuation.

Helping readers answer such vital valuation questions as "What's this company worth?" "Is this a fair valuation?" and "Are we leaving too much money on the table?" Venture Capital Valuation dissects the valuation profiles of some of today's leading corporations, including:

  • Facebook

  • Twitter

  • LinkedIn

  • Microsoft

  • Yahoo!


  • Zogenix

Plus, it includes interviews with venture-backed company valuation experts Jeff Faust, Josh Cashman, and Joe Orlando. Learn how "value" changes rights to cash flow at every stage of a company's evolution with Venture Capital Valuation.

Table of Contents

Acknowledgments ix

Introduction What You Don’t Know About Valuation Will Cost You Money 1

Chapter 1

Using Facebook, Twitter, and LinkedIn to Explain VC Valuation Gains and Losses: How VCs, Angels, Founders, and Employees Give Up Investment Cash Flow Every Day 13

Did Valuation Ignorance Cost ConnectU (and the Winklevosses) $50MM? 14

An Expert Doesn’t Need a 409A Valuation When He or She Has a Certificate and Basic Math 15

Valuing Facebook’s Common Stock Compared to Preferred Stock in Minutes 16

What the Winklevosses Would Have Seen in Any 409A Valuation Report 19

Deriving a Discount for Lack of Marketability for Valuations 27

Facebook at $80 Billion Valuation versus Enron at $80 Billion Valuation 35

Deal Terms, Waterfalls, and the Pre-Money Myth 36

The Pre-Money Myth 44

Summary 56

Chapter 2

Should Venture-Backed Companies Even Consider a DCF Model?: Introducing the Life Science Valuation Case: Zogenix 57

Zogenix: Company Background Summary and Highlights 58

Leaping Forward Just 20 Months, the Company Files for an IPO 64

Order of Valuations Presented in This Case 67

Chapter 3

Valuation Methods versus Allocation Methods Regarding Zogenix 69

Separating Enterprise Value from the Allocation of That Value 69

Valuing Total Equity 72

Using Future Value (FV) and Present Value (PV) to Value Future Cash Flows Today 79

Summary 82

Chapter 4

Applying the Typical DCF Model to a Venture-Backed Company Hardly Ever Works 85

The Gordon Growth Model 85

High Growth Limits the Gordon Growth Model 87

Dividend Irrelevance and Capital Structure Irrelevance 90

Using Comparables (Generally Market Multiples) to Generate a Terminal Value 91

Actual Differences between Angels and VCs versus Perceived Differences 100

Applying Valuation Methods and Allocation Methods at Inception 102

Summary 104

Chapter 5

“Enterprise Value” + “Allocation Methods” = Value Destruction: Undervaluing Companies and Overvaluing Employee Options 107

Most 409A Valuations Undervalue the Company and Simultaneously Overvalue Employee Stock Options 107

Did Auditors Drive Valuators to Overvalue Employee Stock Options? 109

Most 409A Enterprise Value Calculations Ignore the “Takeover” Value of Preferred 113

The Realistic Range of Possibilities Depends on Who the Investors Are 119

Overstating Returns and Understating Returns on the Same Asset (Simultaneously) 125

What Happens to Fund IRRs When You Assume Book Value Equals Market Value? 128

The Real Cost of Fair Value, Fair Market Value, and Enterprise Value 132

Yahoo! Case 137

Chapter 6

Why You Should D.O.W.T. (Doubt) Venture Capital Returns—Option Pool Reserve 159

Unissued Option Pools 159

Value Conclusion Elements Impacted by Option Pool Reserve Assumptions 161

Impact on Parties Relying on Assumptions of VC Investments 176

Chapter 7

If Valuation Can’t Make You Money, Do You Really Need It?: Learning Practical Applications from 183

Applying Studies to Real-World Cases 186

Important Questions to Ask 213

Summary 223

Chapter 8

Don’t Hate the Appraiser (Blame the Auditor Instead) 225

Interview with Jeff Faust, AVA 226

Summary 236

Chapter 9

Don’t Blame the Auditors (Blame the Practice Aid Instead): 409A Valuation Professionals Discussing Topic 820 (FAS 157) with VC CFOs 237

Introduction to the Expert Panelists 238

The Auditor’s Valuation “Bible” 239

SAS101 Tests, PWERMS, and OPMs 240

PWERMS and rNPV/eNPV Models 243

Subjectivity and the PWERM (or “Power”) Method 243

Finding Inputs for the OPM Model 245

Enterprise Values versus Allocations 246

Next Round Pricing and Topic 820 248

Different Ways of Treating Granted, Unvested, and Reserved Options 250

Valuing Warrants in Venture-Backed Companies 252

Quantifying Qualitative Inputs to Value Conclusions for VC-Funded Companies 253

Discounts for Lack of Marketability (DLOM) and Venture-Fund Portfolios 254

Sharespost, SecondMarket as Market Inputs 258

Summary 262

Chapter 10

Now That You Understand Venture Capital Valuation, Share It 263

About the Author 269

Index 271