Venture Capital Valuations

With the growth in the venture capital industry in 2021, valuations have become more prominent. To address this theme, EisnerAmper recently hosted the “Venture Capital Valuations Roundtable,” an event featuring industry leaders discussing the continued growth of deals, investor diversity and valuation trends observed during the year.

The speakers included Ankur Jain, founding partner at Emergent Ventures and Stephanie Wittrock, head of ASC 820 Valuations at Carta. Our own Gautham Deshpande, moderated the discussion.

The panel shared the following statistics from Pitchbook to set the stage for discussion:

• Q3 2021 was an outstanding quarter for VC investment, with almost $83 billion invested in more than 3,500 transactions.
• For the first nine months of 2021, VC investment totaled $238.7 billion in 12,837 deals. VC investment over nine months this year has already surpassed the record of $166.4 billion set in all of 2020 by more than 43%.
• $187.2 billion in exit value was realized in Q3, contributing to a total of $582.5 billion year-to-date—already 101.6% higher than 2020’s record of $289.0 billion.
• As for SPACs, 413 vehicles raised a combined $109.4 billion through Q3, and mergers continue to occur, although the broad selloff since February and underperformance by many SPAC combinations raise questions concerning the viability of these vehicles as a long-term alternative to ‘traditional’ IPOs.

The following themes were discussed during the roundtable:

PE/VC deals are coming at a ‘higher and faster’ rate:

• PE dealmaking is extremely bullish in terms of valuations. There is competition to identify the good assets and there is insatiable demand from investors which has inflated the value of the deal.
• The PE/VC portfolio companies have also witnessed a significant number of exits; for various reasons -- SPACs’ phenomena, taxation matters, etc. The high number of profitable exits also attracts the additional capital from limited partners thereby refueling the entire PE investment cycle.
• Valuation will be dramatic for this year-end, especially for the investments made in the early 2021. Primarily, the investment manager would like to retain the value of its investment based on its recent round. If the portfolio company is not able to maintain the steady expectations factored during the investment period; markdown of such investments cannot be negated for year-end valuations for GAAP purposes.

PE/VC deals – what is ‘the secret sauce’ that is driving these deals even at higher price:

• Deals are competitive in terms of relative valuation; hence they identify portfolios in the preemptive round or in the early stages of fundraising.
• Secondly, the fund managers have a formula and/or are really good at negotiations and if the valuation is within their expectations matrix, they go ahead with the deal.
• There is an expectation that the tax rate will go up, both in terms of the capital gains tax rate and corporate tax rate, which is also driving early exits thereby valuations.

Growing non-traditional investor base:

• Non-traditional investors continue to increase and have been at record high in 2021. VCs owned by single persons or families of high-net-worth individuals continue to pour more capital into this ecosystem.

Addressing valuation challenges as we approach year-end:

• Market transactions dictate updated pricing for the investments; however, continuous monitoring of the investment and assessment of available information is necessary to calibrate the valuation.
• A portfolio company does not double in value in one day; nor go down to zero in a day or a quarter. Venture capital fund managers knows when their portfolio companies are winners, and when they’re not. Most valuation challenges relate to those portfolio companies that fall somewhere on the ‘in-between’ scale, where the exit path is not as clear. Fund managers can identify the trajectories and the trends of the portfolio companies to avoid extreme volatility. Calibrating the information obtained to evaluate the valuation and back testing the accuracy to subsequent exits and/or funding rounds is a good validation of the valuation mark.
• Some fund managers like the use of a quantitative model and will employ an option pricing model (OPM)or probability-weighted expected return method (PWERM) to allocate the fair value amongst different classes of the capital stack and others like to use more qualitative inputs coupled with other data points. If funds have the sophistication to use an OPM or a PWERM or prefer to work with qualitative inputs along with other data points, they are encouraged to partner with an advisor who has expertise in assisting with these valuations.

To conclude, valuations depend on both qualitative and quantitative factors which involve considerable judgment. With all the uncertainties and volatilities in the PE/VC space, communication is key – both internally to the investors and externally, including valuation specialists and auditors.