Fair Value Is About the Path, Not Just the Point in Time

In a previous article, (linkedin.com - the Hardest Stage in Venture Capital Fair Value)

I discussed what I believe is one of the hardest challenges in venture capital fair value: valuing a company that has not raised capital for a considerable period of time.

But behind that challenge lies a broader question:

What are we actually trying to understand when we value a venture-backed company?

At its core, a venture investment is based on a journey.

A company starts with an idea and, ideally, progresses through product development, market validation, revenue growth, scale, and ultimately a successful exit.

Of course, very few companies follow that path exactly as originally envisioned.

Some move faster than expected. Some take longer. Some change direction. Some significantly outperform expectations. And many gradually demonstrate that the outcome investors originally hoped for is becoming less likely.

Fair value should reflect that changing reality.

The Probability of Success Is Constantly Changing

When investors participate in a funding round, the price reflects expectations at that point in time.

Those expectations incorporate a view of the future.

The company may be expected to:

• Launch a product • Reach a revenue milestone • Expand into new markets • Achieve profitability • Raise a future financing at a higher valuation

The investment thesis is therefore not simply:

"The company is worth $50 million today."

Implicitly, it is closer to:

"Given what we know today, there is a certain probability that this company will successfully progress along its expected path and ultimately generate a valuable exit."

From that moment onward, new information starts arriving.

And that information should influence fair value.

Milestones Are Evidence

This is why milestones matter so much in venture valuation.

Suppose a company was expected to reach $10 million in revenue within 18 months.

Eighteen months later it may be at:

• $14 million

• $10 million

• $6 million

• $2 million

These are not simply operational statistics.

They are evidence of how the company is progressing relative to the expectations embedded in the previous valuation.

The same applies to:

• Product development

• Customer acquisition

• Margins

• Cash burn

• Regulatory approvals

• Management recruitment

Each milestone tells us something about the company's progress along its path.

More importantly, it tells us something about the probability of achieving the outcomes investors previously anticipated.

Calibration Gives Us the Starting Point

This is where calibration becomes particularly valuable.

At the time of a financing, we have an observable transaction.

We know what investors paid.

We also know, or should seek to understand, the expectations and circumstances that supported that price.

That gives us a starting point.

At subsequent valuation dates, the question becomes:

"What has happened since then that would cause knowledgeable market participants to change their view of the company's worth?"

If the company has met or exceeded expectations, the probability of success may have increased.

If progress broadly matches expectations, perhaps relatively little has changed.

If milestones have repeatedly been missed, cash is running short, and the next financing has been delayed, the probability distribution may have changed considerably.

Calibration should not simply mean referring back to the last round price.

It means understanding what supported that price and what has happened since.

Companies Don't Suddenly Become Winners or Losers

One of the challenges in venture valuation is that deterioration is often gradual.

A company rarely moves overnight from:

Promising venture investment → Failed investment

Sometimes the progression looks a bit like this:

• Strong initial expectations

• A key milestone is missed

• Growth slows

• Cash burn increases

• The next financing takes longer than expected

• Forecasts are reduced

• New investors become more cautious

• Financing terms become less favorable

Eventually, a down round, disappointing exit, or failure becomes increasingly probable.

Fair value should reflect that progression over time.

Of course, the opposite can happen as well.

A company exceeds milestones, attracts stronger customers, and/or improves its economics -all demonstrating a higher probability of a substantial exit.

As the evidence changes, the valuation should change.

This Is Why Fair Value Is a Process

It is tempting to think about venture valuation primarily in terms of methodologies:Comparable companies, Recent transactions etc

But methodology comes after understanding the company.

The more fundamental questions are:

Where did we expect the company to be?

Where is it today?

What has happened since the last valuation?

What does that tell us about the probability of future success?

How would market participants reflect that information today?

Only then should we decide which valuation methodology best captures that reality.

Why Probability and Optionality Matter

This focus on expectations also explains why probability and optionality are such important concepts in venture capital valuation.

The future of a venture-backed company is rarely a single predictable outcome.

There is usually a range of possible outcomes, from failure or a disappointing exit through to a highly successful one, and the likelihood of those outcomes changes as the company progresses.

That is what approaches such as PWERM and OPM are ultimately trying to capture.

PWERM considers different potential outcomes and the probability of each occurring.

OPM reflects the optionality inherent in an investment where the ultimate outcome remains uncertain and there is still meaningful upside potential.

Neither removes the need for judgment.

In fact, both depend heavily upon it.

The important point is that fair value should reflect not only where the company is today, but what today's evidence tells us about the range and probability of where it may ultimately end up.

The Path Matters

The ultimate ambition behind most venture investments is straightforward:

Invest in a relatively small company today and participate in the creation of a substantially more valuable company tomorrow.

The probability of achieving that outcome is uncertain from the beginning.

But it is not static.

Every reporting period can provide new information.

Milestones are achieved or missed.

Markets improve or deteriorate.

Financing becomes easier or harder.

The company demonstrates more, or less, evidence that it can become what investors originally believed it could become.

That is why I believe venture fair value should be viewed not simply as valuing a company at a single point in time.

It is a continuous reassessment of where the company is on its path and what the evidence tells us about its probability of success.

The calculation gives us the number.

The path explains why the number changed. 

💬 I'd be interested to hear how you approach this.

When valuing a company between financing rounds, how much weight do you place on operational milestones and changes in the probability of success?

And are there aspects of the valuation process that you think deserve more attention than they currently receive?

As always, comments, challenges, and alternative perspectives are welcome.