Venture capital fair value (ASC 820 / IPEV) is a tricky subject, and standard valuation methods don’t always capture the reality of high-risk, high-reward investing. The perspective below provides a fresh take on how VCs can think about fair value.
Market Participants:
The IFRS 13 standard defines fair value based on assumptions that market participants would use when pricing an asset and requires valuations to assume the investment is realized or sold at the measurement date.
VCs are not passive investors; they actively participate in private startup financing. Their expertise lies in assessing potential investments, leading funding rounds, and structuring financial transactions. They understand both the micro and macroeconomic forces shaping the market at any given time. However, despite their deep industry insight, they operate in an information-asymmetric environment:
What VCs Know
VCs possess deep industry knowledge and firsthand insights into market trends, similar transactions, and the underlying forces driving startup valuations. This expertise allows them to make informed investment decisions that, at least initially, align with fair value. Given their active role in financing startups, they qualify as market participants at this stage.What VCs Don’t Fully Control
While VCs are skilled at identifying promising investments, they have limited influence over exit timing, valuation, and broader market conditions at the time of liquidity events. Unlike early-stage funding rounds, where they set terms, exits depend on external factors such as acquirer interest, economic shifts, and public market dynamics. As a result, when assessing final exit values, VCs may not be considered market participants.
Measurement/Reporting Date Considerations
Fair value assumes that the investment is realized or sold at the measurement date. However, expecting an actual exit at each reporting date is unrealistic.
A reasonable interpretation of this requirement is that valuation shouldn’t be based on whether a VC estimates selling its stake, but rather on whether the company itself is selling shares at the measurement date. If the company does sell shares, then the transaction price serves as a proxy for fair value—at least for an initial period.
Think About Investments and Fair Value
VC Investing: More Like an Option Than Traditional Equity
Venture capital investing is fundamentally different from traditional asset classes like private equity or real estate. Instead of aiming for steady growth and modest returns, VCs operate in a high-risk, high-reward landscape.
A VC invests with the expectation that only a few portfolio companies will generate massive returns—potentially dozens or even hundreds of times the initial investment—while most startups fail. This makes VC investing more similar to option trading than conventional equity investing. Like options traders, VCs accept that many investments will expire worthless while a select few will generate outsized gains, driving overall portfolio returns.
Why Transactional Cost Represents Fair Value—At Least Initially
Market Participants Define Fair Value – VCs invest at prices they believe represent fair value. If a company perceived its shares as being worth more, it wouldn’t sell them at that price.
Preference Rights Are Embedded in Share Value – The pricing of preferred shares inherently accounts for liquidation preferences and other rights. These features are already reflected in the investment terms, eliminating the need for additional valuation adjustments at the initial pricing stage.
Waterfall Valuation vs. Option Pricing Model (OPM) – Traditional waterfall valuations may overstate startup valuations, particularly when considering investor preference rights. In contrast, using an OPM—specifically the Back Solver approach—provides a more precise valuation that accounts for liquidation preferences as contingent claims.
What Happens After the Initial Period?
Over time, valuation methodologies evolve. Initially, fair value is closely tied to the transaction price. However, once a startup matures, VCs begin reassessing company value using alternative techniques:
Mark-to-market pricing – Comparing valuations to recent funding rounds or similar companies.
Multiples-based valuation – Applying revenue or EBITDA multiples to establish fair value.
Waterfall allocation – Adjusting valuation to reflect investor preferences and liquidity scenarios.
This transition reflects VCs’ evolving assumptions about financial conditions, market positioning, and future funding rounds—ultimately shaping enterprise value and potential exit outcomes. However, based on fair value principles, methodologies like mark-to-market pricing may not always be the most optimal approach.
Conclusion: Building a compliant VC Fair Value Framework
VCs typically determine fair value by first anchoring it to transactional value before largely shifting toward assumption-based models and market comparisons. In practice, this means estimating the current enterprise value (EV) and running waterfall analyses to determine the fair value of the investment held.
By adopting an approach that integrates optionality principles throughout the valuation process—rather than defaulting to traditional models—VCs can ensure their methodology aligns with their investment philosophy. Using hypothetical new rounds as transactional value proxies, then applying option pricing methodology (such as the Back Solver model), helps maintain fair value calculations that reflect real market dynamics. This ensures compliance with IPEV and ASC 820 standards while avoiding theoretical valuation constructs that may prove difficult to defend.
Disclaimer: the information on this website is meant as a general guide only and should not be used as a source for Fair value methodology. Circumstances may demand different or more nuanced methodology or calculation.
