What If Fair Value Can Help VCs Make Better Investment Decisions?

What If Your Valuation Process Could Improve your IRR?

Fair value is normally seen as a financial reporting exercise.

Something that needs to be done for the accounts, the auditors, and the LPs.

But perhaps we are missing something.

What if the process of determining fair value could actually help VCs make better investment decisions?

There are some relatively simple ways of looking at the value of a venture investment:

• Cost 

• Last Price Per Share (LPPS) from the most recent financing round

• A form of mark-to-market, looking at movements in public markets and comparable companies

All can provide useful information.

But none necessarily forces us to ask what may be the most important question:

What has actually changed in this company since we invested, and what does that mean for a potential exit?

That is where two important concepts behind institutional fair value become particularly interesting:

✅ Milestones 

✅ Calibration

Milestones: What Has Actually Happened?

When a VC invests, there is a view of the future.

The product will develop. Customers will arrive. Revenue will grow. The team will execute. And ultimately, there will hopefully be a significant exit.

Then reality starts providing evidence.

Products launch.

Customers are won or lost.

Targets are achieved or missed.

Management changes.

Markets develop.

Competitors appear.

New rounds are raised.

These are milestones.

But the important thing is not simply recording that they happened.

It's asking:

What does this tell us about where the investment is heading?

Calibration: Do We Still Believe What We Believed Then?

Calibration can sound technical.

The underlying idea doesn't have to be.

When we invested, we formed a view of the company and paid a price based on the information available at the time.

As new information becomes available, we should continually ask:

What has changed?

And:

Do we still believe what we believed when we invested?

Over time, that analysis may lead us towards four very different conclusions.

1. There is still a high chance of a large exit

The company is progressing well and the evidence is strengthening the original investment thesis.

Keep building. Keep supporting it. Potentially invest more.

2. A large exit is still possible, but much less certain

There is still significant upside, but the risk profile has changed.

That should influence decisions around follow-on capital, priorities, and future exposure.

3. A large VC exit is becoming unlikely, but this could still be a very good company

This may be the most interesting category.

Perhaps the company isn't going to become a billion-dollar business.

But perhaps it could become a highly profitable $50 million company.

That's not necessarily a failed company.

It may simply no longer be a VC-type company.

Recognising that early enough creates options.

Rather than raising another $30 million and continuing to chase an increasingly unlikely billion-dollar outcome, perhaps the strategy should change:

• Build for profitability

• Bring in a different type of capital

• Explore a strategic sale

• Consider PE ownership

• Create liquidity through a secondary

• Pursue a smaller exit earlier

The mathematics can be powerful.

A 2x return achieved in three years represents an annual return of approximately 26%.

A 2x return achieved in ten years is only around 7%.

Continuing to chase the original dream can sometimes turn what could have been a good outcome into a write-off.

4. The evidence increasingly suggests the company isn't going to make it

That's valuable information too.

The earlier that becomes apparent, the earlier the VC can decide how much additional capital, management time, and attention it makes sense to commit.

And What About Secondaries?

The same thinking can also change how a VC responds to a secondary opportunity.

Suppose someone offers to buy an investment at a discount to its current carrying value.

The obvious reaction might be:

"Why would I sell at a discount?"

But perhaps that's the wrong question.

A better question might be:

"Compared with selling today, what do I realistically expect to receive from this investment in the future and when?"

If the company remains firmly in Category 1, giving up future upside may make little sense.

Category 2 requires a more difficult risk/reward decision.

But Category 3 becomes particularly interesting.

If the evidence increasingly suggests that the company can be successful but is unlikely to produce the kind of exit originally sought, taking liquidity today, even at an apparent discount, may produce a very attractive return.

And in Category 4, recovering capital today may prove considerably better than continuing to hold.

Of Course, VCs Already Think This Way

None of this is suggesting that VCs don't already ask these questions.

The best investors are constantly reassessing their portfolio companies, evaluating whether the original investment thesis remains intact, and considering what new information means for future outcomes.

What a disciplined quarterly fair value process does, however, is formalise and institutionalise that thinking.

It creates a structured and repeatable framework that requires these questions to be asked consistently across every investment, every quarter:

• What did we believe when we invested?

• What has changed?

• Do we still believe what we believed then?

• What do we now believe about the future?

• And given what we now know, what should we do next?

That discipline is valuable not only for producing better valuations, but potentially for producing better investment decisions.

This Is Where VC Compliant Fair Value Becomes Useful

Milestones, calibration, scenario analysis, OPM, PWERM, and other institutional fair value methodologies are not simply different ways of producing a number.

Used properly, they require investors to continually examine the investment.

• What did we believe when we invested?

• What has happened since?

• What has changed?

• What do we now believe about the future?

• What does that mean for what the investment is worth today?

Do that properly and regularly across a portfolio, and another question naturally follows:

"Given what we now know, what should we do?"

• Continue investing?

• Hold?

• Entertain a secondary?

• Change the company's strategy?

• Look for a different type of investor?

• Pursue an earlier exit?

• Stop putting additional capital into the company?

And perhaps that is one of the overlooked benefits of institutional-quality fair value.

Cost and LPPS can give us a number.

Mark-to-market can tell us what has happened to the market.

But milestones and calibration force us to keep asking what has happened to the investment itself.

And that can lead to something far more valuable than a better quarterly valuation.

It can lead to better investment decisions.