Abstract
Fair value depends on an estimate of the both cash flow and risk, which is not an easy task when valuing startup firms. We present a measurement instrument for the future risk of small and risky firms that follows the major propositions in accounting and finance. It differs from other valuation instruments in looking simultaneously at the assets and liabilities. We test the VBB as a measure for value over time by using a database of VC backed innovative companies that oridary DCF valuation fails to capture their value. We show that the VBB is an effective way to capture the dynamics of the value of high risk firms.
Highlights
The common valuation model in financial economics is based on a perfect and complete market where information is shared by the market participants
The classic textbook financial economics valuation model is built on the assumption of complete and perfect markets where all assets and liabilities are continuously traded in public markets
We run several types of Value Based Balance Sheet (VBB) valuations at each point of time; we present a method that is based on a Genetic Algorithm (GA) software package – Evolver. (Note 14) This method allows us to reach a set of plausible solutions to the multi-dimensional problem of many distributions, creating countless discount factors
Summary
The common valuation model in financial economics is based on a perfect and complete market where information is shared by the market participants. Common valuation models and prctices are based on the perfect market model and they value the assets of the firm only. In this paper we develop and discuss a valuation instrument that address this issue called Value Based Balance Sheet (VBB). The VBB measures in an explicit way the value and the risk of the assets and the liabilities in an imperfect market. In such a world, it is possible and even likely that, given a particular type of assets, there is an optimal set of liabilities (including equity) that together will maximize the value of the firm. Improve valuation of very high risk firms operating in an imperfect market where knowledge is proprietary
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