Valuation of Venture Capital Backed Firms - Guess or Professional Judgment of Agency Risks and Observable Firm Characteristics?

Abstract

Valuing young and innovative companies is a challenging task. Still, determining their economic value is one of the most important issues for investors and entrepreneurs engaged in venture capital financing. We analyze how venture capitalists determine enterprise values of their portfolio firms. We find that the anticipated magnitude of agency risk is a major value driver for young and innovative firms. However, even taking into account agency risks, accounting information and observable firm characteristics remain important value drivers. As a result we provide a valuation framework in which venture capital backed firms may be valued as precise as publicly traded firms. This shows that valuation of venture capital backed firms is not a guess.