Venture Capital Valuation: Case Studies and Methodology, + Website

CHAPTER 5

“Enterprise Value” + “Allocation Methods” = Value Destruction

Undervaluing Companies and Overvaluing Employee Options

This is perhaps the most important chapter in this book because it gives any reader an opportunity to make money using the information that's about to be presented. How?

In the early chapters of this book, I made the following assertion: The terms “value” and “valuation” are used a lot for high-growth private companies and that's a bad thing. It's bad because when founders, VCs, angels, attorneys, CFOs, CEOs, and employees use these words and don't truly understand what they mean, those same people end up losing lots of money as a result.

If that assertion is true, which every case we've presented thus far supports, then there's an opportunity to realize a profit simply by recognizing verifiable errors in investment cash flow potential embedded in mechanically high- or low-value conclusions related to venture-funded companies.

MOST 409A VALUATIONS UNDERVALUE THE COMPANY AND SIMULTANEOUSLY OVERVALUE EMPLOYEE STOCK OPTIONS

Although we begin the discussion here with respect to employee options, all equity securities in venture-backed companies are essentially call options on an exit opportunity, as opposed to simply rights to future earnings per share. In the case of preferred stock, there are additional options embedded, including calls to roll over the position and related puts to protect prior purchases, through anti-dilution protection. If you can definitively ...