Venture valuations: Can’t I just use my latest PMV?

With time between rounds averaging about 26 months, according to Aumni data, venture capital finance teams face a critical decision: can they continue holding an investment at the latest post-money valuation (PMV), or should they contemplate markups, markdowns, and other more comprehensive valuation approaches? Each approach offers insights and implications, and understanding their differences is essential for making informed decisions. 

This blog aims to help VC finance teams weigh the pros and cons of each approach and make the right call for their portfolio and reporting needs. 

Let’s explore the considerations.

Understanding post-money valuation (PMV)

As background, PMV is a straightforward metric that represents the value of a company after a financing round, including the new capital raised. It is calculated by adding the amount of capital raised to the pre-money valuation. The private markets equivalent to enterprise value, PMV is often used as a benchmark for assessing a company’s worth and determining the ownership percentage of new investors. 

Most venture capital valuation policies state a fund can hold an investment at the latest PMV for up to 12 months after a primary equity financing. But as time passes after a company’s equity financing, venture finance teams must consider the potential limitations of simply relying on the latest PMV when determining fair value.

Benefits of using PMV: 

• Simplicity: PMV is easy to calculate and provides a clear snapshot of a company's value post-investment. Dividing PMV by the number of fully diluted shares outstanding quickly allows venture finance teams to calculate a per-share value that can be applied to the number of shares held by the fund. It offers a quick reference point for investors and stakeholders.
• Benchmarking: PMV serves as a benchmark for comparing a company's valuation to its peers, helping investors gauge its market position.
• Often represents the latest arm’s length transaction: When determining fair value, funds typically calibrate to the latest arm’s length transaction. The latest PMV often represents that standard and is defensible in an audit context. 

Limitations of PMV:

It’s important to recognize that PMV, while useful, can sometimes be misleading. Imagine a company that raised a round at a $1 billion post-money valuation during a market upswing, only to exit a year later at $400 million after market conditions shifted and growth expectations weren’t met. In such cases, relying solely on the last PMV would have significantly overstated the investment’s fair value. 

• Lack of depth: PMV does not account for the complexities of a company's capital structure, growth potential, or market dynamics. 
• Static nature: PMV is a static metric that does not change until the next financing round, potentially overlooking shifts in market conditions or company performance, especially if time between rounds elongates.
• Audit scrutiny: While the latest PMV is often defensible in an audit, if your PMV remains unchanged for 18-24 months or more, be prepared for auditors to ask for justification or evidence that the value is still current and reflective of market conditions. 

Exploring alternatives to the latest PMV

Simple markups/markdowns

If it is determined that there have been material changes to the fundamental performance of the business, most funds adjust fair value through percentage discounts or premiums to the last round to capture the perceived fundamental changes.

Consistent application of markups or markdowns based on company or market performance is key to successful fair value determination.  

Market approach valuations

Funds that want to run more robust valuations typically consider market approach methods, such as the Guideline Public Companies (GPC) approach. Once an equity value is determined via the market approach methodology, allocation of that value to the share classes can be done either with Common Stock Equivalent (CSE) or the Waterfall Method (also known as the Current Value Method – CVM).

Common stock equivalent

This methodology assumes all securities in the capitalization of a company convert to common shares (as is common in the event of an IPO, for example) and assumes that every share will be valued at the same price per share. The benefits of this approach are its simplicity (simply divide the calculated value of the company by the fully-diluted shares outstanding), though the drawbacks are that it ignores the material economic rights and preferences of different securities within the capital stack. 

Waterfall method – CVM

An exit waterfall is a structured framework that outlines the distribution of proceeds in the event of a sale or liquidation. It models claims on cash and the order and priority in which investors and stakeholders receive their returns. Exit waterfalls are crucial for understanding the potential outcomes of an exit scenario and ensuring a fair distribution of proceeds.

Benefits of running an exit waterfall:

• Comprehensive analysis: Exit waterfalls provide a detailed analysis of potential exit scenarios, offering insights into the distribution of proceeds among stakeholders.
• Scenario planning: Exit waterfalls allow firms to model different exit scenarios, helping them anticipate potential outcomes and make strategic decisions.

Limitations of exit waterfalls:

• Complexity: Exit waterfalls can be complex to model and require a deep understanding of the company's financial structure and stakeholder agreements.

Conducting comprehensive valuations

Comprehensive valuations involve a thorough analysis of a company's financial health, market position, and growth potential. They incorporate various valuation methodologies, such as market approaches, income approaches, and asset-based approaches, to provide a holistic view of a company's worth.

Benefits of comprehensive valuations:

• Depth of analysis: Comprehensive valuations offer a deep dive into a company's financials, providing a nuanced understanding of its value.
• Market context: By considering market dynamics and industry trends, comprehensive valuations reflect the true worth of a company in its competitive landscape.
• Strategic insights: Comprehensive valuations provide valuable insights for strategic planning, helping firms make informed investment decisions.

Limitations of comprehensive valuations:

• Time-consuming: Conducting comprehensive valuations can be time-consuming and resource-intensive, requiring detailed analysis and data collection.
• Subjectivity: Valuation methodologies can be subjective, and the results may vary based on the assumptions and inputs used.

Learn more in our report, created in partnership with leading VC audit firm Sensiba, about venture valuation policies.