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Effective vs. Nominal Valuations in Venture Capital Investing

31 Pages Posted: 27 Sep 2005  

Michael Woronoff

Proskauer Rose LLP; University of California, Los Angeles (UCLA) - School of Law

Jonathan Rosen

Applied Minds

Abstract

Any serious conversation between venture capitalist and entrepreneur ultimately leads to the issue of valuation of the enterprise. The discussions typically focus on some combination of pre-money value, the amount of capital being raised, and post-money value.

In turn, these values may be used to calculate a percentage of the company being sold. The entrepreneur will typically use these amounts to compare offers from different investors, or in the absence of multiple offers, as one of the primary items of negotiation.

The focus on the nominal pre-money and post-money value and ownership percentage, though common, is misguided. All parties would be better served by focusing on the actual value that will flow to each party upon a monetization event (or exit), which will be only partially dependent upon the percentage ownership implied by the pre- and post-money valuation contained in the term sheet. As obvious as this advice may seem, it typically goes unmentioned in even sophisticated discussions of the valuation of venture capital deals. Indeed, some actually counsel against this advice, arguing that cash flows are not significantly affected by factors other than price, so these other factors should not be overemphasized.

This Article explores how the structure of the typical venture capital transaction can significantly affect the distribution of value among various interested parties upon exit.

Keywords: valuation, venture capital, pre-money, post-money

JEL Classification: G32, K12, K22

Suggested Citation

Woronoff, Michael and Rosen, Jonathan, Effective vs. Nominal Valuations in Venture Capital Investing. NYU Journal of Law and Business, No. 2, p. 199, 2005. Available at SSRN: https://ssrn.com/abstract=803124

Michael Woronoff (Contact Author)

Proskauer Rose LLP ( email )

Eleven Times Square
New York, NY 10036-8299
United States

HOME PAGE: proskauer.com

University of California, Los Angeles (UCLA) - School of Law ( email )

385 Charles E. Young Dr. East
Room 1242
Los Angeles, CA 90095-1476
United States

Jonathan Rosen

Applied Minds ( email )

Los Angeles, CA 90024
United States

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