Rethinking venture capital valuation: How alternative techniques could strengthen investor confidence

By Paul Silcock, Assurance Director, PwC Channel Islands

The lack of venture capital (VC) deals over the past two years has made it hard to benchmark valuations. But other valuation options are available. By improving fund managers’ ability to gauge the potential of pre-revenue enterprises and take account of today’s challenging market conditions, fresh approaches to valuation could strengthen governance and investor confidence.

The wealth of VC expertise within the Channel Islands has made it a leading centre of fund administration and service. VC funds provide quality employment within our islands, while helping to channel investment into life sciences, climate tech and other innovative start-ups and scale-ups.

However, the past two years have been difficult for VC funds as a combination of inflation, high interest rates, geopolitical instability and declining valuations have driven down both fundraising and deal activity.

Could we see an upturn in VC transactions in 2024? Fund managers remain cautious, with interest rates likely to stay high for some time and economic conditions still fragile. But VC dry powder is at record levels and needs to be put to work. There are also pockets of sustained investment growth to build on including climate tech.

Balancing risk and reward

So how can fund managers balance the risks and rewards as they look to step up investment?

Value maximisation and operational excellence are clearly critical. With the high costs of capital and limited margin for error, it’s more important than ever to validate, execute and target plans to enhance revenue generation and improve balance sheet optimisation. Both financial sector expertise and data-driven strategic analysis are key, helping to create a value creation mindset all the way from deal hypotheses to close- and post-deal realisation.

We’re also likely to see greater specialisation in both strategy and market focus as fund managers seek to identify and unlock untapped value. While larger funds’ ability to invest in talent and technology gives them an edge, there is still room for smaller and niche players to harness their specialist expertise.

Valuing with greater insight and confidence

Valuation is at the heart of value optimisation in this challenging and uncertain market.

Without a history of revenue generation, early-stage enterprises have always been difficult to value, especially in testing economic conditions. Right now, the challenges are exacerbated by the sharp fall in VC dealmaking, which means that there are fewer transactions against which to benchmark valuations. The result is a Catch 22 in which uncertainty over valuations leads to even fewer deals being agreed and even fewer benchmarks being available.

More dynamic and sophisticated valuation techniques could bring greater insight and certainty to investment valuations. Particular attention is focusing on the option price model (OPM) backsolve approach. Using the Black-Scholes or similar option pricing model, OPM backsolve draws on recent arm’s length equity transactions to derive the implied value of the enterprise and each of the securities held. OPM backsolve is especially useful in valuing companies with complex capital structures such as those where classes of equity have different rights and obligations.

Other useful techniques include milestone analysis. By focusing on the progress and achievements of a company, this approach offers a more detailed picture of its future potential. The results allow investors to align their valuations with the company’s developmental stage and market position, while helping them to project eventual revenues.

Find out more

Our colleagues in PwC Luxembourg recently published Venture capital evaluation: Adapting to a changing landscape. The article is well worth a read if you want to find out more about evolving VC valuation techniques and how we at PwC are supporting their development.

If you would like to know more about how we can help your business, please feel free to reach out to discuss this topic further.

Contact us

Paul Silcock

Paul Silcock

Assurance Director, PwC Channel Islands

Tel: +44 7700 838286

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