Venturenomics: Adjusting for Three Standard Practices May Reduce Venture-Backed Company Pre-Money Valuations by 90%

Abstract

This Article illustrates how pre-money valuations of venture capital-backed companies may be overstated by 10X.This is because venture capital math (VC Math) ignores the economic impact of three standard practices. First, VC Math treats a company’s unissued (and even non-existing) stock options as outstanding shares of stock. Second, VC Math ignores the fact that much of a company’s common stock, and options to purchase common stock, have not yet been earned. Third, VC Math values a share of common stock and a share of convertible preferred stock equally, despite the fact that convertible preferred stock was intentionally created to be worth more.

Keywords: VC Math, Entrepreneurship Finance, Venture Capital, Startup Valuations, Preferred Stock Rights

JEL Classification: G32, G24, M13, K22