Valuation of venture capital investments: empirical evidence

Abstract

Using the valuation data of 421 US venture capital transactions and 176 initial public offerings, we test a simple binomial valuation model in modelling the risk‐return profiles of venture capital investments. We find that the model is consistent with the previous knowledge on the risk‐return profile of venture capital investments. The results also confirm the hypotheses that early‐stage ventures have higher implied risk and implied volatility of the returns than more established ones.Additionally, we analyse the predictive power of the binomial pricing model and compare it to corresponding ‘traditional’ models that utilize risk‐adjusted rates of return. We construct one‐step ex post return forecasts for the sample ventures and compare the results to the actually realized returns. The findings indicate that the fit of the binomial model is better than the fit of the corresponding ‘traditional’ models.The results imply that option‐based methods have empirical relevance in the pricing analysis of privately held companies and projects. Furthermore, practitioners can benefit from using these methods when analysing the risk‐return structure of private companies and R&D projects.