Should we invest in “risk”?

RiskManagementSolutionsVinod Khosla, a prominent Silicon Valley venture capitalist, once said: “I am only interested in technologies that have a 90 percent chance of failure.” The success of technology-based companies such as Google, Genentech, or Sun Microsystems leads many observers to believe that Vinod’s strategy has worked so far. While focusing on outliers in forecasting investment performance can be misleading, Cambridge Associates’ U.S. Venture Capital Index does report healthy returns for venture capital investments.

If Vinod’s strategy is the one to follow, is it because i) we are buying risk or because ii) we are buying assets on the cheap?

Valuation theory may appear confusing on the subject. On one hand, we are expected to pay less for a $1 of future cash flow when it is associated with greater uncertainty. The discounted cash flow approach to valuation is built around this concept. On the other hand, publicly traded stock options cost more when the volatility of the underlying stock is high. Certain commonly used valuation techniques treat venture capital equity as a stock option where the volatility of underlying economic, industry, and business factors translates into higher intrinsic values.

Valuation theory around complex financial instruments such as stock options may be about as intuitive as international tax law. A stock option is a contract to buy or sell the stock at a certain price. The volatility of the stock does contribute positively to the value of the stock option. But so does the value of that stock.

Stock prices incorporate future expectations. Companies with 90 percent chance of failure would trade at heavily discounted prices. Thus, even if we treat Vinod’s equity as a stock option, higher volatility should be offset by a much lower underlying stock price. In other words, for Vinod’s strategy to work, investments should be just as cheap as they are risky.

More Updates

Intellectual Property, Goodwill, and Other Intangible Assets

The predominant amount of S&P 500 value comes from intangible assets and goodwill (“Intangibles”) of the underlying companies. It is no surprise that patents and brands are more valuable than desks. Understanding the components of intangible value is of great relevance to tax authorities and financial stakeholders.

Many Ways to Define Business Value

“Our business is worth $10 million,” they said.  So the buyer only needed $6 million cash to buy it. There are many ways to talk about what a business is worth.  In the above example, $10 million can be Business Enterprise Value, while $6 million is the value of equity.  The buyer assumed a $4 million bank loan. Here are

Balance Sheet Matters in Business Valuation

Can you find a business valuation estimate on a financial statement? The balance sheet contains the book value of equity, which is the first approximation of what the company is worth.  The number would actually be pretty good if it weren’t for unaccounted-for intangible assets and goodwill.  For recently acquired companies, the book value of equity is exactly fair market

Schedule a Call

Most new projects will require a brief introductory conversation. Unless you are a returning client asking for an update to a old valuation, please use the calendar below to schedule a call with us:

Send a Message

We are located in the San Francisco Bay Area, while our clients cover much broader geography, from Southern California to the East Coast and Europe. Please contact us with questions and inquiries. Also, feel free to stop by on your way to the beautiful Sonoma or Napa Valley.

Schedule a Call