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Venture Capital Valuation
by Aaron Kleiner

Valuation of early stage companies is certainly much more an art than a science and it is an extremely important art to both the entrepreneur and the venture capitalist. Recently a venture capitalist associate of mine shared with me his firm's thinking about evaluating companies and I would like in turn to share his thoughts with you. William R. Lonergan of Oxford Partners stated that there were three major factors his firm looked at in evaluating deals:

  • The Management
  • The Market
  • The Technology
Though venture capitalists vary, to some extent, in the weighting they apply to each of these factors, most of them would weigh management the heaviest, perhaps with as much as 40 or 50%. Perfection to a venture capitalist is:
  • A company with a management team that has done it before, successfully
  • A company that is in a large and/or rapidly growing market
  • A company which has a unique and protectable technology
Needless to say, they seldom find real perfection. The reason for recapping the above is that it bears on the valuation process. Oxford would like a potential portfolio company to be able to grow to something in the range of $25 to $50M revenue in 5 years. This sort of growth -- assuming the company has become profitable along the way -- fits their valuation model expectations.

In a general sense, Oxford targets on realizing 10 times its investment in 5 to 10 years or, as another way of looking at it, they aim for a 25 to 35% compound rate of return. In order to do this calculation, it is necessary to work backward from the projections in the Business Plan.

Bill noted that few start-up companies -- probably less than 10% -- achieve the revenue, or profit, projections in their original Business Plan, so they often make some downward adjustment in this area. They also use a PE ratio of 10 in these calculations even if the company may have used a higher number in its own projections.

Some other valuation guidelines they have used to evaluate companies in other portfolios:

  • For a profitable, rapidly-growing company, the lower of 2X sales or 1 0X NPAT
  • For a stagnant, but profitable company, the higher of 1 X sales or 1 0X NPAT
  • For a deteriorating or unprofitable company, with technical capability, 1/2 of sales
I want to thank Bill for allowing me to present this information. I hope it will prove of some benefit to you.

Reprinted with permission from The MIT Enterprise Forum, Inc. of Cambridge. The article first appeared in the "Forum Reporter," Volume 7, No. 7, March 1989.

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