Can anyone point me basic steps of valuing a venture capital opportunity? I understand the need to use a much higher discount rate, but can anyone else give me other practical examples that I should consider?

I heard a finance professor once say that to determine the discount rate you find a successful VC fund that is raising money and use their historical returns as the actual discount rate. That is return that investors are expecting for the risk, thus it is the cost of capital. It makes sense to me.

“I heard a finance professor once say that to determine the discount rate you find a successful VC fund that is raising money and use their historical returns as the actual discount rate.” I would use the return of a VC index if one exists for the discount rate.

if you want you can always look at what ‘parts’ make up the discount rate or that are used to discount a value. these include firm size premiums, control discounts, minority discounts, sector premiums, country premiums, liquidity premiums, ‘other’ premiums (to account for transparency in reporting or lackthereof, confidence in management etc)… etc etc. generally most people i’ve talked to about this suspect that a 30% discount rate, give or take would be in the area of what people are looking for. I have no data to back up a 30% discount rate though so i can’t verify if that’s close to accurate or way off…but does give you something to think about.

I would assume that there is a term structure to these premia, or does one just average them together with some kind of IRR?

what do you mean by term structure? (i’m sure its obvious to you, but i want to be sure i understand what you’re asking before i respond with a real post).

Maybe term structure isn’t the right word, but VC generally takes a long time to start paying off, so your rate of return may depend on how far forward you are planning and how long the company has been funding. I guess you could look at historical returns and use an IRR method over the long term and just recognize that you are unlikely to get that rate with young firms.

They typically discount the expected value at the point of exit (via IPO/strategic sale) using a minimum hurdle rate for the VC firm. The exit value is can be estimated by multipying the avg. P/E multiple in that industry with the projected earnings just before exit, then discount at a hurdle rate.

If you take out the top 5 firms or so, historical VC returns are actually quite bad, given the risk and liquidity of the investment. If you’re considering a VC deal and Kleiner Perkins isn’t in the deal, you should probably pass.