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Valuation of Early-Stage Ventures: Option Valuation Models vs. Traditional Approaches

Author

Listed:
  • Robert H. Keeley

    (University of Colorado)

  • Sanjeev Punjabi

    (Deutsche Bank North America, New Yor)

  • Lassaad Turki

    (Menlo Park, CA)

Abstract

This paper presents a new method for valuing early stage ventures, a method which views new ventures as multi-stage call options. It examines the traditional methods for valuing such ventures--the ubiquitous Discounted Cash Flow (DCF) Method using a risk adjusted discount rate, and the Venture Capital method which uses high discount rates to offset optimistic forecasts--and describes their conceptual disadvantages visa vis the Option Method. In order to make the Option Method a practical alternative to traditional approaches, the paper presents an algorithm for valuing multi-stage options, and it develops the needed input data using venture capital archives and public offerings. The Option Method is applied to a typical early-stage investment, producing values close to those predicted by venture capital "rules of thumb." In contrast, the DCF method badly underestimates the value of the venture. At this time the Option Method is a practical way to value early-stage ventures, both internal ventures and start-up companies. It offers many advantages over the venture capitalists' s "rules of thumb."

Suggested Citation

  • Robert H. Keeley & Sanjeev Punjabi & Lassaad Turki, 1996. "Valuation of Early-Stage Ventures: Option Valuation Models vs. Traditional Approaches," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 5(2), pages 115-138, Summer.
    • Handle: RePEc:pep:journl:v:5:y:1996:i:2:p:115-38
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    References listed on IDEAS

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    Cited by:

    1. Wolfgang Stummer, 2002. "Some Potential Means for Venture Valuation," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 7(3), pages 39-52, Fall.
    2. William W. Wilson & Lee Vetsch & David W. Bullock, 2022. "Valuing an agricultural technology startup using real options," Agribusiness, John Wiley & Sons, Ltd., vol. 38(4), pages 771-785, October.
    3. Yao-Wen Hsu, 2010. "Staging of venture capital investment: a real options analysis," Small Business Economics, Springer, vol. 35(3), pages 265-281, October.
    4. Damiano Montani & Daniele Gervasio & Andrea Pulcini, 2020. "Startup Company Valuation: The State of Art and Future Trends," International Business Research, Canadian Center of Science and Education, vol. 13(9), pages 1-31, September.
    5. Liu, Yu-hong & Jiang, I-Ming & Hsu, Wei-tze, 2018. "Compound option pricing under a double exponential Jump-diffusion model," The North American Journal of Economics and Finance, Elsevier, vol. 43(C), pages 30-53.

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    More about this item

    Keywords

    Early-Stage Ventures; Startup; Valuation; Open Valuation Model;
    All these keywords.

    JEL classification:

    • M13 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - New Firms; Startups
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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