Derive the main valuation inputs and value a private equity stake in venture, growth-equity and buyout deals, interpreting what the figures imply
The idea
In the venture capital method, post-money value = expected exit value ÷ (1 + target return)ⁿ, the required stake = investment ÷ post-money value, and pre-money value = post-money − investment. An exit of 200 in five years, a 40% target and 10 invested give post-money of 37.19, a 26.9% stake and pre-money of 27.19. For later dilution, divide the required stake by the retention ratio. Growth equity applies DCF or multiples to firmer forecasts. In a buyout, exit equity = exit EBITDA × exit multiple − net debt. Equity growing from 200 to 500 over five years is 2.5×, an IRR of about 20.1%. The trap is reading high venture target rates as expected returns: they allow for both failure risk and optimistic founder forecasts.
Formulas
Post-money value in the venture capital method
post-money value = exit value ÷ (1 + r)ⁿ
- exit value
- the expected value of the company at exit
- r
- the investor's target rate of return
- n
- the years to exit
Pre-money value is post-money less the investment. The high target rate is meant to cover both the risk of failure and founders' optimistic forecasts.
Ownership a venture investment must buy
ownership = investment ÷ post-money value
- investment
- the amount invested now
- post-money value
- the company's value just after the investment
If later funding rounds will dilute the stake, divide by the retention ratio, the share of their ownership existing holders keep. 10 invested at a post-money of 37.19 needs 26.9%.
Equity value at a buyout's exit
exit equity = exit EBITDA × exit multiple − net debt
- exit EBITDA
- the company's EBITDA at exit
- exit multiple
- the enterprise value ÷ EBITDA multiple expected at exit
- net debt
- debt less cash still outstanding at exit
Paying debt down between entry and exit raises exit equity even at an unchanged multiple. Compare with the equity invested for the money multiple and the IRR.
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