The VC (Venture Capital) method is one of most common approaches among practitioners of private company valuation (not only VC analysts, despite the name). It is quick to implement and suitable for every startup development stage.
As a general principle, valuation is the price investors would pay to enter the company today, while the exit value is their expected gain in the future. The VC method assumes that they invest if their ROI (Return on Investment) is above certain thresholds.
In fact, because startups remain risky even after the investment, professionals expect poor exits from most companies in their portfolios. They need to look for ventures able to generate high ROIs, since the succeeding ones must generate extra returns to compensate the losses of the others.
Starting from these considerations, the method works backward:
- The potential exit value of the company must be estimated
- The valuation is computed as the present value of the exit gain where the ROI is the applied discount rate
Potential Exit Value
This value is computed with a multiple approach: the EBITDA from the last projected year (Earnings before interest, taxes, depreciation, and amortization) times an industry-based EBITDA multiple.
Napebook, Inc. are developing a social network for hairdressers. They project to have an EBITDA of USD 380,000 in three years. Their core activity implies they belong to the Social Media & Networking industry, whose EBITDA multiple is 24.2.
The resulting potential exit value is therefore: USD 380,000 × 24.2 = USD 9,196,000.
The earlier the stage of development of the company, the riskier is the investment, and thus, the higher the required ROI. You can learn more about the rates Equidam applies in VC method's required ROIs.
The net present value of the exit after n projected years is computed with the ROI as discount rate and is equivalent to the post money valuation of the company. A simple subtraction of the capital raised results then in the pre-money valuation.
Napebook is an early stage company. They are in the development stage (still writing the code of their platform and testing early results), so the required ROI implies a 114.74% return rate. The current valuation of Napebook is computed as
USD 9,196,000 / ( 1 + 114.74%)^3 = USD 929,000.