Venture Capital: In need of new valuation tools?

Venture capital investing has become a major contributor to the growth of innovative start-up firms. According to Bergemann and Hege (1997) venture capital has grown to be the financing mode of choice for projects where uncertainty of future pay-offs are high.


Investing in start-up firms carries a substantial risk of failure, only a minority of start-ups is high-return investments. This put great responsibility to the valuation methods used by the venture capital firm. It is argued that when uncertainties about future pay-offs are high traditional valuation tools are of little help, they are said to be too static and not to comply with change. A valuation method that is alleged to act in accordance with a changing environment where uncertainty is high is real option which is said to consider these variables, thus giving a more accurate valuation. The structure of venture capital funding can be seen as well suited for real option valuation.


1 Introduction
1.1 Background
1.2 Problem formulation
1.3 Purpose
2 Method
2.1 Choice of method
2.2 Literature
2.3 Selection
2.4 Interviews
2.5 Validity & reliability
3 Theoretical framework
3.1 Venture capital
3.2 Investment process
3.3 Valuation process
3.4 Traditional valuation methods
3.4.1 Comparables
3.4.2 Multiples
3.4.3 Net present value
3.4.4 Payback period
3.4.5 Internal rate of return
3.4.6 Scenario planning
3.4.7 Decision tree
3.4.8 Disadvantages with the traditional methods
3.5 Real option approach
3.5.1 Different types of options
3.5.2 Disadvantages with the real option approach
3.5.3 Real option in venture capital
4 Empirical findings and analysis
4.1 Characteristics of the invesment process
4.2 Use of valuation methods
4.3 Real options embedded in the investment
5 Conclusion
5.1 Further studies

Author: Töre, Hedro,Gustavsson, Anders

Source: Jönköping University

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