Pros and Cons of Fair Market Value When Setting up a Price Round

Hype and rational in VC world

Pro #1: Trading Comp Valuation Doesn't Fit with the Early VC's Job Itself.

Comparing a disruptive startup like Airbnb to traditional hotels illustrates the limitations of using trading comp valuation. Early-stage venture capitalists are often dealing with companies that have unique business models and don't have direct competitors in the traditional sense. FMV allows for a more tailored approach to valuation, taking into account the innovative nature of these startups.

Pro #2: Because There Is Necessarily a Moment of Convergence Between Both Valuation.

The idea here is that even if a startup has a high initial valuation, it can be justified if it has the potential to outperform the market in the long run. Patience on the part of investors is key. Over time, as the company's performance aligns with its valuation, there can be a convergence point where the high valuation is justified by the company's growth and success.

Pro #3: Fair Market Valuation Fails to Weigh Strategic Value.

FMV might not fully account for the strategic value of a company. If a startup has a well-defined exit strategy that includes being acquired by a larger company, a valuation method like the Probability-Weighted Expected Return Method (PWERM) could be more suitable. PWERM takes into consideration strategic factors that FMV may overlook.

Con #1: Fair Market Value Helps Tackle FOMO and Hype.

While it's tempting to invest in technology at a high premium, there's a risk that what seems cutting-edge today might become commonplace in the future. FMV acts as a safeguard against over-enthusiasm and encourages a more realistic valuation, preventing investors from getting carried away by short-term hype.

Con #2: Staying Realistic.

In response to Pro #2, while there may be a convergence point between a company's valuation and its market value, it's essential to ensure that the inputs driving that convergence point are sustainable. Overly optimistic valuations can lead to issues like downrounds, dilution, or even fire sales if the company fails to meet inflated expectations.

Con #3: Navigating Lows and Legal Quirks.

Overvaluing a company can result in paper riches for investors but can also lead to significant tax liabilities. FMV helps in avoiding such pitfalls by providing a more balanced and realistic assessment of a company's worth.

In a Nutshell: Keeping It Down to Earth

In summary, while it's acceptable to assign a premium valuation to a startup, it's crucial to maintain a balance between optimism and realism. Early excitement and innovation can wane over time, and market conditions can change. FMV serves as a reminder to stay grounded and make informed investment decisions, taking into account not only a company's potential but also its long-term sustainability and market dynamics. Balancing aspiration with caution is key to successful venture capital investing.

Want to calculate the FMV when setting a price round? We can help.

*Given that InitialRevenue1 = $15,000 million, GrowthRate1 = 14%, InitialRevenue2 = $400 million, and GrowthRate2 = 150%
We can set up the equation: $15,000 million * (1 + 0.14)^t = $400 million * (1 + 1.50)^t
Now we can solve for "t":
(1.14)^t = (1.50)^t
Taking the natural logarithm (ln) of both sides:
ln(1.14)^t = ln(1.50)^t
t * ln(1.14) = t * ln(1.50)
Divide both sides by ln(1.14):
t = ln(1.50) / ln(1.14)
t ≈ 9.38