Purpose Venture Capital Insights : Valuation
Venture Capital with Impact, commonly referred to as Social Entrepreneurship or Impact Investing, has evolved from a "nice to have" to an indispensable and integral component of most investment portfolios. The new generation of High Net Worth individuals, coupled with current market conditions and challenges, has reframed the priorities of wealthy investors to focus on social issues. Investments opportunities are plentiful, but choosing the right ones to not only deliver the desired financial return but also ensure growth and social impact is a major challenge. In today's brief overview, we would like to highlight which Venture Capital valuation methods are commonly used and how these, combined with an impact valuation model, can make the selection process unique and ensure portfolio excellence for a modern investor.
Let us first frame what Venture Capital companies are and how they differ from other types of investment companies. According to Investopedia, Venture Capital (VC) is a form of private equity and a type of financing that investors provide to startup companies and small businesses that they believe have long-term growth potential. Venture capital generally comes from wealthy investors, investment banks and other financial institutions.
Valuation methods in VCs
Valuation of VCs and especially those with impact and purpose is the most difficult task for any VC investor and analyst. None of them have a crystal ball to predict the future and the impact of external and internal factors when they decide to put their money to work. Below I have outlined 5 methods that I believe are the most widely used and provide the best overview of the valuation process when investing in VCs. Keep one very important fact in mind: despite a high valuation, the political, geographic and reputational implications and risks must be considered.
Prospective methods (i.e. DCF and discounted earnings)
Looks at the valuation of the company or venture on Discounted Cash Flow. This used to be the most widely used valuation method, primarily considering projected sales figures and pipeline strength. Needless to say, this is a good valuation method for manufacturing and sales driven organisations. It did not consider brand valuation or the strength of broadly defined ecosystems or management.
Comparators-based methods (i.e., multiples)
My favourite valuation method looks not only at the sales projection but also other surrounding factors. Multipliers are specific to the industry in which VC operates and the projection of similar structures at further development stage. Typically, multipliers vary from 5 times to 10 times the current year's Goodwill and sales figures.
Historical cost-based valuation method
Challenging method for early stage VCs as it requires detailed analysis of historical costs incurred including POC and POT including R&D. It usually results in a lower valuation that is not in favour of the founders.
Liquidation value-based valuation method
In my opinion, an interesting method used for VC and PEs in distress that need a capital injection or are looking to be reorganised. The focus lies on the cost of liquidation and potential opportunity costs/losses.
SPAC valuation and marketability
A new and unique method of valuing companies is to use a market model assuming SPAC market entry. We have seen a huge increase in SPAC deals in recent months that allow startups or VCs in later stages of development to be publicly available. It is clear to say that SPAC valuation is really a blank cheque Special Purpose Vehicle.
Impact Investment Valuation
Evaluating the impact of social ventures remains a complicated and contentious issue, as it is very difficult to measure what level of impact is appropriate and what level should be considered sufficient. I decided to share with you the proprietary model developed by Rise and Bridgespan following SROI, which is a predictive method for estimating on a pre-money basis the financial value of the ESG-based good that is likely to result from each dollar invested. In this way, social impact investors, whether corporate or institutional, can evaluate the projected return on an opportunity.
There are 6 steps to follow to identify the feasibility and impact of a given venture:
Assess Relevance and Scale: Is the social or environmental impact measurable and how many people can the product or service potentially reach?
Identify Evidence-Based Outcomes: Define social or environmental outcome goals and use existing data and research to determine if the outcomes are measurable and achievable.
Estimate the Economic Value of Those Outcomes to Society: Select an anchor study that will serve as the evidence base for the projected impact of the investment. Then use economic research to assign a monetary value to the projected social or environmental change.
Adjust for Risks: IMM uses an "impact realisation" formula that estimates the probability of achieving the projected social or environmental value.
Estimate Terminal Value: Estimate the likelihood that the scale and social or environmental value created will continue for five years after an investment term ends.
Calculate the Return on Every Dollar Invested: Begin by adjusting the total projected social value of the investment to reflect investor's share relative to the ownership stake. Then, determine the IMM by dividing the projected social benefit of the investment.
As shown in the previous sections of this short article, the selection of the valuation method of a particular VC is not only subjective, but depends heavily on the stage of development of the company. In different funding rounds the method may vary to better reflect the current stage of development and provide more accurate planning for the development and growth of VC. In the case of social enterprises, the financial outcome is often less than the social impact and therefore, for certain investors, the valuation needs to be linked to ensure a complete and detailed picture of the strategy and focus of the company. Social Ventures state the real focus in its mission and therefore its IMM needs to be fully integrated and considered in the investment decision.
In conclusion, no one solution is the best and not all methods are suitable for each and every venture or investor. A mix and match comparison should be considered to reflect the company's mission and vision while ensuring stable and adequate governance.
1.  Rojo Ramírez, Alfonso & Galvez, Maria Del Mar & Canadas, Juana. (2010). The Methods Used to Value Investment by Venture Capital Firms. Revista Española de Capital Riesgo. 3-13. 2. https://www.bridgespan.org/insights/library/impact-investing/calculating-the-value-of-impact-investing , 2021
ABOUT THE AUTHOR
Nicolas Huras is a member of the advisory board for Purpose Venture Capital. Nicolas is an experienced leader in asset management, fintechs and impact investing across Europe and Asia. He chairs the Digital Innovation Committee of Investment Management Association of Singapore IMAS. He has served as a senior director in leading Banks and Asset Managers, a Partner at a fund administration boutique and created an impact advisory firm in Switzerland focusing on Venture Philanthropy in 2012. He brings a wealth of experience skilled in linking traditional finance to impact investing and venture philanthropy for our portfolio companies and investors.