Damodaran on Valuation

Questions: 1. Discuss the risk factors involved in venture capital investing.2. Explain the private equity valuation methods of an entity. Answers: 1. The various risks factors involved in venture capital (VC) financing are mentioned below (Damodaran, 2006). Business macro environment- While the VC financing is typically done on the basis of estimated future projections, but despite the most conservative estimates, it is quite likely that the economy may enter into a slump or the industry dynamics may significant be altered which can result in failure of business. Timely exit The VC tends to profit on their investments by offloading their stakes either to a PE (Private Equity) investor or liquidate during or after the IPO (Initial Public Offering). Management Team The success of a new business would essentially depend on the intrinsic motivation and skills on the management which is a huge risk especially in case of limited previous experience. Risk regarding product or service on offer Since VC typically provide seed funding i.e. funding at the initial stages, thus it is not clear whether the underlying product or service would be received well by the customer and would be able to achieve the projected sales growth. 2. The private equity valuation methods are explained below (Damodaran, 2006). Analysis of comparable company The PE investors tend to value the private entity based on the valuation received by a peer group company which is publicly traded. Some discount and premium may be extended for specific differences. Analysis of precedent transactions The previous transactions of similar size in the same industry are considered with regards to the valuation multiple deployed. DCF Analysis This is primarily deployed for mature businesses where the future cash flows are relatively easy to determine which are discounted to determine firms value. Sum of parts Analysis In this the various operating businesses are individually valued through any of the above and the sum is arrived for valuation. Reference Damodaran, A 2006, Damodaran on Valuation: Security Analysis for Investment and Corporate Finance, 2nd edn, Wiley Publications, London