Venture capital (VC) institutions search for budding business ideas in the industry. They usually invest in businesses that might offer exponential returns. Companies with a high chance of growth also have high risks. VC institutions don’t finance a project only based on a hunch. Before investing in a project, they evaluate the returns and losses. With the help of organizational evaluations, venture capitalists analyze the performance of a business. From market research to return prediction, many things complete a project evaluation. Venture capitalists use several methods to evaluate a company’s performance before investing. Read on to understand some methods for organizational evaluations by venture capital.
The common methods for organizational evaluations
VC institutions use a wide range of evaluation methods to assess a business’s performance. Some organizational evaluation methods used by venture capital institutions are as follows:
- The conventional method
In the conventional method, market evaluation is necessary. First, the ratio between the price and earnings of securities is determined. Venture capitalists focus on the time of starting and quitting the investment. Usually, the annual revenue of the organization for the upcoming 7 years is predicted. This revenue metric follows an upward trend after each year. Venture capital institutions compare the cost of investment with the earnings at the time of quitting the investment. During the investment tenure, tax deductions are also taken into account.
Venture capital firms demand a net worth of at least 40% of the total value of the business. The NPV (Net Present Value) is also considered in the conventional method of organizational evaluation. Venture capitalists struggling with the conventional evaluation method can always seek VC support.
- First Chicago evaluation method
The First Chicago is a little different from the conventional method.
Here, the emphasis is not on the starting and quitting time of investment. Instead, it is on the profit made during the investment period. Three positions for investments are considered in the First Chicago method: success, failure, and sideways survival. Venture capitalists give a probability rating to each position. If the probability rating for success is higher than the other two positions, the investment opportunity is right. Venture capitalists can implement the First Chicago evaluation method with the right VC support.
- Revenue multiplier evaluation method
It is one of the common organizational evaluation methods used by venture capitalists. In this method, the borrowing concern depends on an estimated value. The present value of the borrowing concern is known to the venture capital firm. This is how the expected revenue rate, holding period, and profit margin are estimated by the firm. The revenue multiplier method is applicable for investments expected to multiply in revenue over the years.
Some firms also have personalized evaluation methods for making the right investment choices.
Venture capital firms might not implement the evaluation methods without financial experts. They seek VC support to use organizational evaluation methods and find the right investment opportunities!