On the Valuation of Venture Capital Securities
50 Pages Posted: 25 Mar 2008
Date Written: March 18, 2008
Abstract
Venture capitalists typically receive preferred stock when they invest. This preferred stock comes in many flavors and can include many different features. The resulting securities can be modeled as a portfolio of options with unknown expiration dates, with these expiration dates possibly correlated to underlying firm value. These securities can provide a significant premium to plain common stock, but past solutions for this premium are either unwieldy or require unrealistic assumptions. In this paper, we derive closed-form solutions for the value of VC securities using a flexible functional form that allows for a wide variety of realistic assumptions for the key parameter values. We then take this solution to the data and estimate the expected premium above common stock for typical VC securities. We find that this premium can be substantial, with estimates between 20 percent and 60 percent for the most common types of transactions.
Keywords: venture capital, valuation
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