The study focuses on Venture Capital Methods and other aspects of venture capitalism. Venture Capital determination has several analytical tools and methods to implement the Venture model. This study focuses on the two major venture models: the Venture Capital (VC) method and the Discounted Cashflow Valuation method. In this study, the Venture Capital method is identified and utilized properly to identify the venture capital process of an organization (Köhn 2018).
The appropriate calculation and discussion will be applied with the help of the Venture Capital method. These calculations will help identify the venture scope and capital determination of the Cambridge Covid-19 Vaccine Venture. The present values of the venture are identified with the help of compound annual methods of Venture Capitals.
The idea of the venture capital method is to reflect the method of venture capital and how it only involves investors who are willing to exit the market in the next 3 to 7 years (Akkaya 2020). The venture capital approach or model provides the best solutions to the investors who are not willing to play for a longer period of time. This model of venture capital is the most suitable for valuing the early stage. The pre-revenue companies get the opportunity to create better pricing for their valuation approach.
Under this model, an expected exit price is created at the very beginning so that the investments can be properly estimated. From this assumption, the entire process is reversed as the calculation goes back to the situation of post-money valuation, where the time and risk of the investors are considered entirely (Sivicka 2018). The risk and return on Investment are easily achievable from the venture capital method as it estimates the determination power of how the return can be expected from the particular Investment. Based on the positive aspects, investors can always expect a certain amount of return from the investments but with a specific level of risk (Metrick and Yasuda 2021).
The implementation of the Venture Capital Method is possible through the pre-revenue companies and their estimation of the existing value potential. This evaluation criterion will help to prevail the certain milestones when they are reached (Gornall and Strebulaev 2020). The companies are free to utilize the Venture Capital method at any point in time but mostly after certain milestones have been reached. The significant formula of the Venture Capital Method is stated below.
Expected Return on Investment (RoI) = Exit Value / Post-money Valuation
which means
Post-money Valuation = Exit Value / Expected Return on Investment (RoI)
Based on the understanding of Discounted Cash Flow method of Venture Capitalism, it directly takes the free cash flows into consideration which are generated through the future. These cash flows generally come from specific projects or companies that are generated on the basis of their future valuations.
The discounting values are only used in the case of the Weighted Average Cost of Capital. The Discounted Cash Flow (DCF) is a significant valuation method that estimates the value of investments by focusing on the expected future cash flows (Fernandez 2019). DCF valuation method creatures a better justification for the projections of money that will be generated from the investments directly. The DCF method helps in evaluating the decisions of the investors related to the venture capital process (Vayas-Ortega et al. 2020).
There are some basic assumptions that are required to be made while determining the valuation method of DCF. The assumptions of the Discounted Cashflow method are the future cash flow, the time period, discount rate, growth rate and terminal value (Trejo-Pech and Thompson 2021). Without the appropriate assumptions of these factors, the concept will fail to be determined, and eventually, the scientific result will also not conclude upon anything. The intrinsic values can be determined and calculated if the appropriate DCF formula is implemented (Fernández 2019). The formula of Discounted Cash Flow method is stated below.
DCF = CF1/(1+r1) + CF2/(1+r2) + CF3/(1+r3)
DCF = Calculated DCF value
CF = Cash Flow
r = Discount rate (WACC: Weighted average cost of capital
The implementation of DCF is entirely focused on evaluating the time value of money. Here, the assumptions will help to critically assess the future expected cash flows of the present values. This valuation method can be implemented at any company where the DCF analysis is analyzing the profitable situation where the investment return rate is analyzed (Damodaran 2020). The Discounted Cash Flow is analyzed and determined to gather information regarding the potential investment returns and the highest initial investment return rates of multiple investments. The DCF helps in customizing and making the decision about investment acceptance and declination.
On the other hand, the terminal value shows the venture’s capital method at the end of the explicit forecast period. The financial analysis process takes care of the business beyond the explicit forecast period within the DCF model. Here, the Gordon Growth Model ad the Discounted Cash Flow model is computed to get the Terminal value which includes all the future cash flows of the particular projected period (Devigne et al. 2018). Without the terminal value model, the financial model of the forecast period cannot be done or completed.
Figure 1: Terminal Value and Explicit Period Graph
(Source: Self-created by author)
Here, the Earning value (E) stands at $600000, and the number of shares (S) is 150000.
The formula of Earning Per Share (EPS) is E/S.
EPS=E/S
EPS= $600000/150000
EPS= $4 per share
In the second step, the price earning relationship of the comparable firm is considered. Here, the (P/E) is calculated by dividing the Current Price (P), which stands at $60 per share, with the comparable earnings per share (EPS), which stands at $4 per share.
P/E of comparable firm =. P/EPS
P/E = $60/$4
P/E = 15
In step 3, the last calculation will be done to determine the value of the firm at the end of 3 years (V). The formula for determining the valuation is to multiply the price earning relationship of the comparable firm (P/E) that is 15, along with the net income (NI) of $1.3182 million.
The formula for determining the valuation of a firm at the end of 3 years is stated below.
V = P/E of comparable firm x NI
V = 15 x $1.3182 million
V = $19.773 million
Therefore, it can be evaluated that at the end of three years, the value of the Vaccine venture will stand at $19.773 million.
The calculation of the present value of the venture (PV) will be determined after dividing the value of the venture (V) at the end of four years which is stated as $19.773 million or 19768000 by the Annual rate of return “R” and the sum of 1 that is 30% for the period of 4 years.
The formula for determining the present value of the Covid-19 vaccine venture is stated below.
PV = V / (1 + R) T
PV = 19768000 / (1 + 0.30)4
PV = $6921326.284
This shows the Present Value of the Cambridge Covid-19 vaccine venture after implementing a 30% compound annual rate of return, which stands at $6921326.284.
Percentage of Ownership = I / PV
I = $3000000
PV = $6921326.284
Percentage of Ownership = $3000000/$6921326.284
Percentage of Ownership = 43.344%
Therefore, 43.344% of ownership has to be compromised of the Cambridge Covid-19 Vaccine venture to get the $3 million Investment.
Conclusion
In this subject, the venture capitalist firm is trying to invest in the Cambridge Covid-19 vaccine venture by determining the different potentials of the VC. The two major venture capitals will be discussed with the help of assumptions applications. The discounted cash flow valuation will also be judged on the basis of explicit forecast period and terminal or horizon values. In this study, the importance of venture capital methods has been identified properly through which the Cambridge Covid-19 vaccine venture is justified. The determination of venture capital method and other aspects has identified that 43% ownership needs to be compromised to the VC firm in order to get the $3 million contributions which is a good deal as there is the majority of 57% ownership of the vaccine venture that lies with the host company. The control stays in favour of the Cambridge vaccine even though a justified investment has been done on behalf of the VC firm.
References:
Akkaya, M., 2020. Startup valuation: Theories, models, and future. In Valuation Challenges and Solutions in Contemporary Businesses (pp. 137-156). IGI Global.
Damodaran, A., 2020. Discounted Cashflow Valuation: Equity and Firm Models.
Devigne, D., Manigart, S., Vanacker, T. and Mulier, K., 2018. Venture capital internationalization: Synthesis and future research directions. Journal of Economic Surveys, 32(5), pp.1414-1445.
Fernandez, P., 2019. Three residual income valuation methods and discounted cash flow valuation.
Fernández, P., 2019. Discounted cash flow valuation methods: examples of perpetuities, constant growth and general case. SSRN.
Gornall, W. and Strebulaev, I.A., 2020. Squaring venture capital valuations with reality. Journal of Financial Economics, 135(1), pp.120-143.
Köhn, A., 2018. The determinants of startup valuation in the venture capital context: a systematic review and avenues for future research. Management Review Quarterly, 68(1), pp.3-36.
Metrick, A. and Yasuda, A., 2021. Venture capital and the finance of innovation. John Wiley & Sons.
Röhm, P., 2018. Exploring the landscape of corporate venture capital: a systematic review of the entrepreneurial and finance literature. Management Review Quarterly, 68(3), pp.279-319.
Sivicka, J.O., 2018. Features of valuation of startup companies. ??????????? ???????, (132), pp.163-174.
Trejo-Pech, C.J. and Thompson, J.M., 2021. Discounted cash flow valuation of conventional and cage-free production investments. International Food and Agribusiness Management Review, 24(2), pp.197-214.
Vayas-Ortega, G., Soguero-Ruiz, C., Rojo-Álvarez, J.L. and Gimeno-Blanes, F.J., 2020. On the differential analysis of enterprise valuation methods as a guideline for unlisted companies assessment (I): Empowering discounted cash flow valuation. Applied Sciences, 10(17), p.5875.
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