The Most Important Input into Venture Fair Value Isn’t a Multiple. It’s Judgement.

When a venture fund makes an investment, it does not begin with a valuation model; it begins with an assessment of the company.

Does this company fit our investment strategy? Do we believe in the management team, the technology and the market? What needs to happen over the next three to five years for this company to succeed? How much additional capital is likely to be required, and where will we sit in the cap table after future rounds? Most importantly, if the company succeeds. Can our investment, with its particular rights and position within that cap table, generate the return we require?

That is what venture investors are good at. It is the expertise, experience and judgement that led them to make the investment in the first place.

And, as I read the IPEV Guidelines and the US fair value framework under ASC 820 and the AICPA guidance, that same judgement should be at the heart of how VCs subsequently assess fair value.

Every Quarter Is Another Investment Decision

A useful way to think about quarterly fair value is as a disciplined reassessment of the original investment thesis: compare the company’s current position with the milestones and expectations established at the investment date.

Not literally, of course. The original investment matters enormously. In fact, it provides the starting point for calibration. But the intellectual exercise is remarkably similar.

At the original investment date, the investment team formed a view of the company and its potential future development. Perhaps the expectation was that Product 1 would reach beta in Year 1, Product 2 in Year 2, commercial rollout would begin in Year 3, ARR would reach €30 million in Year 3 and €75 million in Year 4, the company would expand from UK into the US and Europe, and a further €60 million of financing would be required along the way.

These were not simply milestones in a business plan. Collectively, they formed part of the expectations underpinning the investment decision and the price the investor was prepared to pay.

Now move forward two years.

The investor has considerably more information. Product 2 may be six months late, but revenue may be ahead of plan. The US expansion may have been slower than expected, while customer retention has been considerably stronger. Perhaps the company has required more capital than anticipated, or perhaps it has achieved significantly more with less.

The fair value question is therefore not simply whether a comparable-company multiple has moved from 8x to 6x. It is: what has actually happened to the company, and what do those developments do to the probability, timing and size of the potential outcome that originally justified the investment?

That is calibration, and it is fundamentally an exercise in investment judgement.

The Market Participant Has Information a Model Does Not

The people making this assessment are not disinterested observers trying to infer the company's value from a database. They are the market participants who made the investment.

They performed the original due diligence, negotiated the price and the rights, understood the business plan, considered the likely financing requirements, assessed management and thought about the potential exit outcomes. Since investing, they may also have spent months or years watching the company develop, participating at board level and seeing information that no public-company comparable or transaction database could possibly capture.

That accumulated knowledge is enormously valuable. Yet quarterly valuation processes can sometimes appear to put much of it to one side and focus instead on a more easily measurable question: what multiple are comparable companies trading at today?

Comparable-company data is useful evidence, and in the appropriate circumstances it can be an important part of the valuation. But it should not substitute for the much richer question: what did we believe when we invested, what has happened since, and what does that tell us about the company today?

This Is the Part a Computer Shouldn't Do

Technology has an important role in venture fair value. It can maintain the cap table, model dilution and future financing rounds, calculate waterfalls, perform an OPM backsolve, run PWERM scenarios and sensitivities, preserve assumptions and evidence, and create the audit trail required for a robust valuation process.

Computers are very good at those tasks, and increasingly there is little reason for highly skilled investment professionals to spend their time doing them manually.

But the most important part of the process, applying judgement, is fundamentally different.

Did achieving a particular milestone materially reduce risk? Does missing another one change our expectations for the company? Has the probability of a successful exit increased or decreased? Has the likely timing of that exit changed? Does the company still have a credible path to the outcome on which the original investment thesis was based?

These are not primarily modelling questions. They are investment questions requiring experience, context and judgement. They are precisely where the fund manager adds value.

Fair Value Should Build on the Original Investment Thesis

This is why calibration is so important.

At the investment date, the transaction price and terms provide observable evidence.

But behind that transaction sits an investment thesis. The investor has effectively concluded that, given what is known about the company, the risks being taken, the capital structure, expected future financing and the range of potential outcomes, investing at that price and on those terms can produce an acceptable return.

For a venture fund, that analysis goes further than simply asking whether the company itself might ultimately be worth €500 million or €1 billion. The investor must consider what its own holding could be worth after dilution, future financing and the application of the economic rights within the cap table - and whether that outcome is capable of generating the returns required by the fund.

The investment connects those original expectations with the original transaction.

Subsequent fair value then asks how the evidence has changed those expectations, in a word, calibration.

If the company has delivered broadly according to plan, that tells us something. If it has significantly exceeded its milestones and reduced execution risk, that tells us something else. Equally, if development is twelve months late, substantially more capital is required and the expected exit has moved out three years, the assumptions that supported the original investment have changed materially.

Market movements and comparable-company multiples can provide relevant evidence in making that assessment. But they are evidence within the analysis, not necessarily the analysis itself.

Let the Investor Assess the Investment

There is an irony here. The parts of fair value that often receive the greatest attention — finding multiples, manipulating spreadsheets, maintaining cap tables and running valuation models — are increasingly the parts that technology can automate.

The difficult part is the part that cannot be automated so easily: assessing a company under uncertainty and deciding what the available evidence means for the range of potential outcomes.

That is essentially the same skill the VC exercised when deciding to make the investment in the first place. It is the expertise and experience of the investment team, and it is where they should add the greatest value to the quarterly fair value process.

The objective of technology should therefore not be to replace that judgement, but to give it structure: capture the original expectations and assumptions, track the milestones, identify what has changed, model the consequences, apply the appropriate valuation methodology and maintain the evidence and audit trail.

That leaves the most important question with the people best qualified to answer it:

Given everything we know about this company today, how has our assessment of this investment changed since we made it?

That, rather than mechanically marking an investment to the latest market multiple, is where venture fair value should begin.

Fair value should use technology to support investment judgement - not replace it.