Startup Valuation by Venture Capitalists: An Empirical Study

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Startup valuation by venture capitalists: An empirical study
Article in Venture Capital · April 2012

DOI: 10.1080/13691066.2012.667907
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Venture Capital
Vol. 14, Nos. 2–3, April–July 2012, 151–174
Startup valuation by venture capitalists: an empirical study

Tarek Miloud*, Arild Aspelund and Mathieu Cabrol
Department of Finance, Chambery Business School, Savoie Technolac,

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Le Bourget du Lac Cedex, France

(Received 2 March 2011; final version received 14 February 2012)
How to value a new venture is critical in entrepreneurial financing. This article

develops an integrated theoretical framework to examine whether venture
capitalists’ valuation of a new venture can be explained by factors identified in
the strategy theories as important to firm performance. Empirical results from the
analyses of 184 rounds of early-stage venture capital investments in 102 new
ventures support the central proposition that venture capitalists do take into
consideration those factors that are important to firm performance in their
valuation of new ventures. More specifically, this article finds that attractiveness
of the industry, the quality of the founder and top management team, as well as
external relationships of a new venture significantly and positively affect its
valuation by venture capitalists when it seeks venture capital financing in its early
stages of development. These empirical findings help to establish an initial linkage
between the well-developed theories in strategic management and under-
researched venture capital valuation practice. It brings more theoretical rigor to
the venture capital investment literature by introducing a systematic approach to
identify and measure factors important to new venture valuation. It explores a
possibility to develop a supplementary method to value an early-stage new
venture when extant valuation methods fail to yield consistent results because
these methods require accounting information that a new venture typically cannot
provide.
Keywords: startup valuation; venture capital; entrepreneurial finance
Introduction
How should an entrepreneur value his startup company when he seeks equity
financing from a venture capitalist? And on the other side of the table, how do
venture capitalists value a prospective entrepreneurial firm when they make an
investment decision? These are two central questions that entrepreneurs and venture
capitalists have been struggling with for generations. Yet, currently there is no
systematic answer to these two important questions. To identify good solutions are
essential for both the entrepreneur and the investor for many reasons.
For the venture capitalists, the valuation is important because the value of the
company determines the proportion of the shares they receive in return for their
investments, guides the overall profitability of their fund and thus also affects their
relationship with their fund providers. Likewise, the valuation is important for the
*Corresponding author. Email: tmiloud@gmail.com
ISSN 1369-1066 print/ISSN 1464-5343 online

Ó 2012 Taylor & Francis
http://dx.doi.org/10.1080/13691066.2012.667907
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152 T. Miloud et al.
entrepreneur as it governs the motivation and sets a value to the efforts and resources
he puts into his new venture. More than that, research has shown that the valuation
is important because it aligns the ambitions of the entrepreneur and investor, helps
structure and assure a fair treatment (Clercq et al. 2006) and reduces the sources of
potential conflict between the entrepreneur and the investor (Zacharakis, Erikson,
and Bradley 2010). The seminal venture capital study by Tyebjee and Bruno (1984)
shows that the venture capital investment follows a somewhat well-defined process –
starting from deal origination and ending at the exit of investment. In this staged
process, the valuation of an entrepreneurial firm is one of the most important and
challenging issues facing both entrepreneurs and venture capitalists. Tyebjee and
Bruno (1984) maintain that establishing the price of venture capital is the heart of
any negotiation between the founders of the venture and potential investors.
According to mainstream finance theory, the economic value of any investment is
the present value of its future cash flows (Brealey, Myers, and Allen 2007). Simple as
it is, this axiom definition of economic value presents a challenge to financial
valuation methods when applied to valuating a new venture. The commonly used
valuation techniques in corporate finance (e.g. discounted cash flow method, earning
multiple method and net asset method, etc.) depend on strict assumptions and
require information that new ventures typically cannot provide (such as accounting
information). Hence, their applicability is severely limited in valuating early-stage
new ventures and both venture capitalists and entrepreneurs are frustrated by huge
variance of valuations computed from the extant methods for exactly the same new
venture. Practically, the practice of startup valuation by venture capitalists remains a
‘guess’ and ‘alchemy’.
The need for more rigorous research in venture capital investment, in general, has
also been recognized by many prominent entrepreneurship scholars. For example,
Barry (1994, 3) points out that ‘in spite of the intriguing issues in venture capital
finance, relatively little has been published on this subject in the most influential
finance journals’. Furthermore, some studies (see, e.g. Waldron and Hubbard 1991;
Hall and Hofer 1993; Gompers 1999) review studies of startup valuation in both the
entrepreneurship and corporate finance literature and find that there is a gap in the
extant literature. More recently, several studies in the entrepreneurial finance
literature have investigated the factors that influence the investment process. For
example, Silva (2004) studies venture capitalists’ (VCs) decision-making and finds
that their attention is focused on the entrepreneur, the business idea, its sustainable
advantages and growth potential. According to his study, the financial projections of
the prospect do not seem to play a major role in the selection of early-stage projects.
Levie and Gimmon (2008) explain why there is a suboptimal evaluation by investors
of the human capital of first-time high tech venture founders – they support the idea
that there is a gap between in-use and espouse investment criteria, and extensive use
of gut feeling in decision-making.
These studies show that there is a great need for a better understanding of startup
valuation for both practical and theoretical reasons. Venture capital investment in
general, valuation in particular, is a very important entrepreneurial phenomenon and
we do not know sufficiently about this critical aspect of the entrepreneurial process.
This study aims to contribute by performing a quantitative empirical investigation of
the influence of non-financial, strategic factors on the actual valuation of French
startup firms. We identify the most influential factors for firm performance from three
different but complementary strategic perspectives – industry organization economics,
Venture Capital 153
resource-based view and network theory for our analysis. The result is the first step on
an alternative route to startup valuation based on strategic analysis rather than
manipulation of ‘imaginary’ numbers.
Theoretical framework and hypotheses

According to the finance literature (Brealey, Myers, and Allen 2007), the valuation
process of the firm is complex because of the diversity of factors that come into play.
It goes far beyond pure financial considerations of balance sheets, income statements
and the financial forecasts. For example, industry characteristics, such as intensity of
rivalry, entry and exit barriers, and firm characteristics, such as its development stage
and competitiveness, are qualitative rather than quantitative factors which
significantly influence firm value. To gain insight into these factors for valuation
purposes, we need to look to other theories than finance for directions. In particular,
the entrepreneurship and strategic management literatures provide us with
considerable insight on the antecedents of firm performance and how value is
created in an entrepreneurial process.
Over the past half century, several theories have been developed to explain and
predict firm performance and value creation. Three of these are of particular
relevance to our startup valuation context: (i) industry organization economics, (ii)
resource-based view and (iii) network theory. Each of these theories approaches the
central issue (firm performance) from a different perspective. The industry
organization tradition focuses on the structure of the market in which firms
compete and highlights the importance of industrial structure in determining firm
performance. The resource-based view conceptualizes the firm as a bundle of
valuable resources and stresses the importance of internal resources in predicting
firm performance. Bridging the two ends of the spectrum, network theory
underscores how the external relationships of a firm channel resource flow and
shape its strategies, and hence impact its performance. By putting them together, we
seek to develop an integrated framework to estimate the value of a startup.
This theoretical framework suggests that firm resources, external ties and market
opportunities jointly determine firm performance, which is unobservable ex ante, but
is the theoretical base for firm value, upon which venture capitalists and
entrepreneurs negotiate their individual estimates of the valuation. Through
negotiations between the venture capitalists and the entrepreneur over their
estimations of future economic performance of the startup, their estimations
converge and the deal is priced. The logic of this approach is straightforward. The
constructs (and related variables) in the framework have been found important to
firm performance in the strategy literature. If financial methods relying on an
estimated future cash flow can come up with a valuation for a new venture, the
strategic management approach developed here can achieve similar (or better) results
when future cash flow is difficult to estimate but input factors that influence future
cash flow can be objectively measured. Obviously, when it is difficult to value a
subject based on output (future cash flows), pricing it based on inputs (entrepreneur,
industry attractiveness, etc.) may be a better alternative than ‘pure guess’. As the first
exploratory study applying strategy theories to startup valuation, this study may not
completely solve the problem, but based on accumulated knowledge of the strategy
field over the past half century, empirical findings in new venture performance and
venture capital investment literature, and discussions with entrepreneurs and venture
capitalists, there are substantial justifications that the model will perform well.
According to Dittmann, Maug, and Kemper (2004), the use of multiple valuation
methods significantly reduces the failure rate of funding agreements between venture
capitalists and entrepreneurs.
The framework also has high internal consistency. A fundamental similarity
between industry organization economics and the resource-based view is that both
theories assume competition is the ultimate force that drives (or determines) firm
performance and any factors – exogenous or endogenous – that impede the
competitive forces that are positively related to firm performance. Industry
organization theory takes an exogenous perspective by focusing on industry
environment in which a firm competes. It identifies the structural conditions under

which the competition is likely to be offset and firms can expect to earn above-
normal return. On the other hand, the resource-based view looks inside the ‘black
box’ of firm and highlights the importance of firm-specific (and endogenous)
resources. It identifies the characteristics of firm resources that are likely to be
immune from competition.
Furthermore, Lee, Lee, and Pennings (2001) have proposed that the resource-
based view should and can be complemented by the network theory. The authors
argue that these two perspectives have divergent concerns with the roots of value
creation, with resource-based view stressing the internally accumulated resources or
capabilities while social capital theory underscores its relational characteristics with
external entities. The two theories ought to be synthesized (to study firm
performance); since startups should develop firm-specific assets while obtaining
complementary external resources through their social networks. Indeed, their
results suggest that ‘resource-based view and social capital theory need to be
simultaneously considered and integrated to better account for entrepreneurial
wealth creation’.
In the following, we will draw from the three selected strands of strategic
management literature to hypothesize on how central factors in industry organiza-
tion economics, resource-based view and network theory affect new venture
valuation by venture capitalists.
Industry organization and startup valuation

To examine the effects of industry structure on startup valuation, we focus on two
key structural elements from industry organization economics, namely the degree of
product differentiation and industry growth rate. We propose that both these factors
will influence on firm valuation. Industry profitability and market size will be used as
control variables in the empirical test.
Product differentiation
Caves (1972) argues that product differentiation is one of the most important
structural elements of an industry and is positively related to firm performance.
Comanor and Wilson (1967) examined consumer goods industries (at three-digit SIC
code level) and found that industries with high advertising intensity earn higher rates
of return on equity. Porter (1980) argues that industries characterized by low
product differentiation require new entrants to attend to cost and capacity
considerations, which encourages retaliation against entrants and decreases venture
Venture Capital 155
performance. Extrapolating from these empirical results on firm performance, we

propose:
H1 – The degree of product differentiation of an industry is positively related to the

valuation of new ventures in this industry.
Industry growth
Hall and Weiss (1967) find that industry growth rate is positively associated with
industry profitability. Porter (1980) argues that because rapid industry growth
ensures that incumbents can maintain a strong financial performance, even though a
new entrant takes some market share, an entrant into a rapidly growing industry
may experience less retaliation. Also, Peltzman (1977) notes that rapid market
growth can be beneficial for small firms in lowering costs and enabling such firms to
more rapidly assimilate critical skills and knowledge needed for effectively competing
in the marketplace. According to Porter (1980), in early stages of the industry life
cycle (when industry growth is usually rapid), the costs of entry may be much less
than the costs would be for later entrants because of the minimum scale of entry is
much smaller. There are initially few entry barriers and seldom dominant actors that
can wield monopolistic power. Thus, early entrants may be able to erect entry
barriers and gain monopoly profits after they successfully enter the market.
Specifically, new entrants entering industries in the introductory stage may realize
the benefits of establishing: (i) product standards; (ii) a reputation in the
marketplace; (iii) higher customer awareness; (iv) high switching costs; (v) control
of scarce resources; (vi) control of distribution channels and (vii) barriers to
subsequent entry. Finally, industries in the early stages of development provide an
opportunity for new entrants to capture the new demand in markets that have
relatively little likelihood of retaliation by established incumbents.
Zider (1998) stresses that the lucrative nature of industry growth has long been
chased by practicing venture capitalists, who usually focus on the middle part of the
classic industry S-curve (where growth is most rapid). They avoid both the early
stage, when technologies are uncertain and market needs are unknown, and the later
stages, when competitive shakeouts and consolidations are inevitable and growth
rates slow dramatically. Venture capitalist usually can give new ventures in a rapidly
growing market higher valuation, just because the market conditions may allow the
entrepreneurs to make some mistakes and the investment is less risky compared with
similar projects in a low growing market (in which even a small mistake may be
vital). Lower risk can usually justify higher valuation. Therefore, we advance the
following hypothesis:
H2 – The growth rate of an industry is positively related to the valuation of new ventures in
this industry.
Entrepreneurial resources and startup valuation

For a startup, the entrepreneur and his management team have been reported as the
most important resources in various streams of research, including venture capital
investment (see, e.g. Tyebjee and Bruno 1984; MacMillan, Siegel, and Narasimha
Subba 1985), entrepreneurial firm performance and survival (see, e.g. Sandberg and
Hofer 1987; Aspelund, Berg-Utby, and Skjevdal 2005) and top management team
(TMT) effects (see, e.g. Eisenhardt and Schoonhoven 1996). The heterogeneity of the
entrepreneurial team in terms of experience, education or function provides a signal
to potential investors and is associated with a higher capital accumulation especially
during an initial public offering (IPO) (Zimmerman 2008).
Assumable, as the most important human resources a new venture can have, the
founder/entrepreneur plays a critical role in initiating and growing the new business.
This fact has been unanimously acknowledged by both academic and venture capital
practitioners, and the positive influence associated with the founder/entrepreneur
can be found in numerous entrepreneurship studies, e.g. Tyebjee and Bruno (1984),
MacMillan, Siegel, and Narasimha Subba (1985), Gimeno, Folta, and Cooper (1997)
and Aspelund, Berg-Utby, and Skjevdal (2005). The resource-based perspective
suggests a positive relationship between human resources associated with the startup
and its valuation.
Entrepreneur
From a venture capitalists perspective, Timmons (1992) assesses that entrepreneur’s
‘track record’ of ‘thorough and proven operating knowledge of the business they
intend to launch’ is very important. Numerous studies on venture capitalists
investment process report that experience (a combination of industry, technical,
management, startup experience) is a very important criterion in funding decisions.
Three types of experience are considered important in determining this track record:
(1) Industrial (technical and/or market) expertise: Siegel, Siegel, and MacMillan
(1993) find that the number of years the entrepreneur has worked in a similar
industry significantly and positively related to sales growth. Similar findings
are also reported by Gimeno, Folta, and Cooper (1997) and that growth
firms tend to be led by entrepreneurs who began their venture based on ideas
developed in their previous jobs. Therefore, we propose:
H3 – A new venture is valued higher if its founder has relevant industry
experiences before founding the venture.
(2) Top management experience: The literature on top management experience

highlights the skills and knowledge gained through managing a hierarchy of
management layers. Its relevance to the performance and valuation of a startup
company is that the founder ‘has been there before’. Thus, he knows the
necessary strategies and organizational structures to grow the tiny new venture
to a larger size that requires more sophisticated management infrastructures to
support. Empirical findings are consistent with this argument. For example,
Gimeno, Folta, and Cooper (1997) find both experiences in both top
management and supervisory positions are significantly and positively related
to return of investment. Therefore, we propose:
H4 – A new venture is valued higher if its founder has previous top management
experiences.
(3) Startup or other entrepreneurial experience: Larson and Starr (1993) argue
that prior startup (entrepreneurial) experience is assumed to yield a
customized set of entrepreneurial skills, a rolodex of network contacts and
Venture Capital 157
a business reputation which are strategic resources that can be leveraged into
future ventures. Rather than ‘starting from scratch’, experienced entrepre-
neurs have accumulated the ‘wealth, power and legitimacy’ which can be used
to surmount the traditional obstacles facing new ventures. Muzyka, Birley,
and Leleux (1996) confirm that the venture capitalists believe that hand-on
direct experience in starting up a new business is an important predictor of
new venture success. Lerner (1994) finds that the venture capitalists
representation on boards of directors increased by 44% for firms in which
the CEO had no prior experience in running an entrepreneurial firm.
Increased board presence of venture capitalists indicates increased needs for
both assistance and monitoring, which incurs more costs for the investors.
Therefore, we propose:
H5 – A new venture is valued higher if its founder has previous startup experiences.
Top management team

Practitioners have always recognized the importance of the entrepreneurial team and
this has also been reflected in the scholarly literature over the past couple of decades.
Eisenhardt and Schoonhoven (1990) state that with increasing technological
complexity and competition, more and more new ventures are founded by teams
rather than single entrepreneurs. According to Muzyka, Birley, and Leleux (1996)
and Franke et al. (2008), the completeness of a new venture management team is a
major concern to venture capitalists. Two features of the team are of great concern
to them, namely the completeness and balance (heterogeneity) of the team.
Consistent with the research tradition in the entrepreneurship literature, we propose
that the characteristics of the entrepreneurial team will partially determine its
valuation.
Solo founder vs. founding team. With the increasing complexity of technologies and
competition in the marketplace, ‘one-man’ shop becomes more and more difficult
to survive – simply because no one can have all the necessary skills and knowledge
to effectively compete. Eisenhardt and Schoonhoven (1990, 510) argue that ‘more
founders means that there are more people available to do the enormous job of
starting a new firm that there is more opportunity for specialization in decision-
making’. The entrepreneurial team plays a key role in the ventures’ valuation by
venture capitalists (Franke et al. 2008). According to Tushman and Anderson
(1986), entrepreneurial teams help attain strategic maneuvers, including attaining
first-mover advantages, forming strategic alliances or developing discontinuous
innovations. We suggest that entrepreneurial teams also allow firms greater agility
to enter markets quickly and maintain responsiveness to changing market
conditions. Members are the repositories of much of the technical and
management knowledge, skills, and ability that make up the intangible assets of
the firm. Likewise, Eisenhardt and Schoonhoven (1990) found that the size of the
founding team is positively related to new venture’s sales growth. Therefore, we
propose:
H6 – New ventures founded by a team of founders are valued higher than those founded by
one founder.
Completeness of management team. Similarly, the completeness of the management

team in a new venture is of importance. In their analysis of the ‘verbal protocols’
generated from venture capitalists investment decision process, Hall and Hofer
(1993) report that ‘should have a balanced management team in place’ is one of the
important criteria to make funding decision. A more quantitative study was reported
by Roure and Keeley (1990). In their study of 36 high-tech new ventures funded by
venture capitalists, the authors consistently find a significantly positive relationship
between the completeness of the management team and four types of measures of
return to investment (including internal rates of return to venture capitalists,
entrepreneur and other equity holders). The completeness of the management team
will not only affect the future performance of the new venture, but also directly affect
the valuation of the new venture by potential venture capitalists. For example, a
well-known venture capitalist states, ‘If we must spend much time to recruit other
managers for him (the entrepreneur), we will definitely value him down’. Zider (1998)
interprets his statement that a complete management team not only carries more
credibility and enhances the chance of success, but also saves time for potential
investors, for venture capitalists routinely assist the entrepreneur in hiring. Siegel,
Siegel, and MacMillan (1993) found that functionally balanced entrepreneurial
teams were positively associated with entrepreneurial firm growth. Therefore, we
hypothesize:
H7 – New ventures with a complete management team are valued higher than those without
one.
External ties and startup valuation

Social network perspective has emerged as an important view to understand firm
behavior and performance. In the entrepreneurship context, Dubini and Aldrich
(1991) emphasize the importance of external ties to understand the start, growth and
expansion of new ventures. The more developed the entrepreneurs’ network, the
easier for them to start and grow their new business. According to Stuart, Hoang,
and Hybels (1999), an entrepreneur’s network plays an important role in the search
for new opportunities, acquisition of resources and gaining legitimacy. First,
network facilitates and constrains the entrepreneur in finding lucrative new business
opportunities. Second, according to Uzzi (1996), once the opportunity is spotted, the
entrepreneurs can leverage their network to pursue the opportunity as the network
provides access to resources, usually at a cost substantially lower than that from the
open market. Finally, Stuart, Hoang, and Hybels (1999) stress that the network is
very helpful when the emerging business requires legitimacy, as more established
institutions (and credible individuals) can extend their endorsement to new
ventures. This is crucial to overcome the information asymmetry between the
entrepreneur and venture capitalists. Zheng, Liu, and George (2010) show in their
sample of biotechnology companies that the firm’s network influences its
performance and therefore, the valuation of the company by venture capital
investors – the younger the firm, the greater is this influence. Other benefits from
network may include know-how and technology transfer, speed and richness of
communication, and trust, cooperation and mutual exchange. Thus, the quantity
and quality of the network ties of a startup should be the salient signals to
venture capitalists.
Venture Capital 159
Network size
Hoang and Antoncic (2002) propose that actors’ differential positioning within a
network structure has an important impact on resource flows and on entrepreneurial
outcomes. According to Gulati (1995), as one of the most important aspects of
network structure, network size has been frequently used to describe the position of a
focal firm in its network.
Analyses of network size measure the extent to which resources can be accessed
at the level of the entrepreneur (Hansen 1995) and the organization (Baum,
Calabrese, and Silverman 2000). Deeds and Hill (1996) have found that the larger the
network size, the more benefits accrue to the focal firm, subject to the constraints of
its capability to effectively manage the network relationships. Stuart, Hoang, and
Hybels (1999) find the more strategic alliances a new biotech venture has formed, the
sooner it will go public and the more money it will raise in an IPO (higher market
valuation). The presence of strategic partners, such as venture capitalists, established
pharmaceutical firms and other business firms, all are positively (significant at
various levels) related to the speed to and valuation of IPO. Therefore, we propose:
H8 – The network size of a new venture is positively related to its valuation by venture
capitalists.
Research methodology
As we are seeking to test proposed causal relationships, we have found a quantitative
research approach to be appropriate. In the following, we will describe our research
design.
Data sources and case selection

The venture capital valuation data come from Thomson Financial Securities Data
(TFSD), which is the leading source of intelligent information for the world’s
businesses and professionals, providing customers all types of business alliances,
including joint ventures, strategic alliances, licensing agreements, research and
development agreements, marketing agreements and supply agreements. According
to Lerner (1994), TFSD is the official data collector of the national association of
venture capitalists and the most authoritative data source for venture capital
investment. Since the valuation data are the outcomes of existing VC valuation
methods, one may question whether we can use them as the dependent variable to
test a complementary, alternative valuation approach. Our choice is consistent with
the finance literature. The central idea is that while each individual investor is not
able to estimate the true value of any asset, the mean of their individual estimates is
always close to the true value, as long as their estimation is independent and the
number of investors is large enough.
Our research focuses on the valuation of early-stage companies because these
stages are the most challenging for practitioners and academic researchers.
Furthermore, the characteristics of early-stage ventures are relatively easy to identify
objectively. In an empirical study of the then widely accepted yet seldom validated
‘stages of development’ thesis in the entrepreneurship literature, Ruhuka and Young
(1987, 165) conclude ‘strong consensus was found on distinguishing characteristics of
ventures in early stages of development . . . consensus on developmental
characteristics diminished somewhat in later stages’. For the purpose of this study,
early stages include seed stage, startup stage and first stage, consistent with Ruhuka
and Young (1987).
The case selection procedures consist of the following steps. The sample firms
must (i) have received their early-stage venture capital funding in the period from 1
January 1998 to 31 December 2007; (ii) be less than 5 years old at the time of
funding; (iii) be French firms and (iv) not be in the financial and insurance sector.
The sample window period covers both ‘hot’ and ‘cold’ market and is right after the
AMF’s (AMF, French Securities Regulator) electronic filling requirement. The
above sampling procedures yield a sample of 102 new ventures in 18 industries
(defined at five-digit NACE code) in the 7-year period.
Measurements
The purpose of this research is to attempt to establish the initial theoretical linkage
between the strategy variables and new venture valuation, not to maximize the
explaining power of the model. While there are different ways to operationalize the
variables in the model, we decided to follow the tradition in respective research
streams while also acknowledge the constraints imposed by the availability of data.
Dependent variable
The valuation of a startup is measured by the pre-money valuation, which equals the
announced amount of valuation minus the money invested at the financing round – a
standard way in the venture capital financing literature among author Gompers
(1995). To make sure that the dependent variable is normally distributed, we did a
Shapiro–Wilk W test to diagnose a possible deviation from normal distribution. The
result shows that the data are not normally distributed. Following Gompers (1995),
we did a log transformation of the raw data and used the logarithm of the absolute
amount of the pre-money valuation to measure the pre-money valuation of a startup
company. After the transformation, the dependent variable becomes normally
distributed.
Independent variables
Industry structural variables. Product differentiation: This has been commonly
measured as the advertising intensity ratio, i.e. advertising expenditures divided by
sales revenue of an industry. Therefore, following Caves (1972), we measure the
degree of product differentiation of an industry as total industry advertising
expenditure/total industry sales.
On the other hand, according to Lerner (1995), venture capital investments are
known to be biased towards high-tech industries. In high-tech industries, firms
aggressively pursue technology superiority and develop products with advanced
technological features. Thus, R&D investment is also an important way for firms to
differentiate. In other words, product differentiation may consist of two dimensions:
perceptual differentiation and innovative differentiation. Therefore, we also use the
average R&D investment over sales of an industry as a measure of R&D intensity to
capture the innovative differentiation as a complementary measure of product
differentiation together with the advertising intensity ratio. We can view the
Venture Capital 161
advertising intensity ratio as a measure of the perceptual aspect of product

differentiation and R&D intensity ratio as a measure of the innovative aspect of
product differentiation.
Industry growth rate: This is measured as the percentage change of the revenue of
an industry in year 2 (T2) over the revenue of the same industry at year 1 (T1).
Entrepreneur/top management team. Industry experience: Any experience involves
both qualitative and quantitative dimensions; both matter in any outcome associated
with this variable. However, there is no perfect way to measure both aspects of
experience. Though a commonly used measure in the literature is to use the number
of years the manager has worked in a particular industry, such detailed information
is not available for most private firms. Indeed, we could find such detailed experience
information for only 23 of the 305 founders in the sample firms. As a crude proxy, we
decide to use a dummy variable to measure the founder’s industry experience, which
is coded ‘1’ if any of the founders has worked in the same industry before, ‘0’
otherwise.
Top management experience: Similarly, the management experience of the
founder/founding team is measured by a dummy variable, coded ‘1’ if any of the
founder(s) has worked in any executive positions (VP and above position), ‘0’
otherwise.
Startup experience: We use a dummy variable to indicate the startup experience
of the founder and/or founding team, which is coded ‘1’ when any of the founders
has founded a firm before, ‘0’ otherwise.
Top management team. Following the TMT literature, we define the TMT as the
top two tiers of an organization’s management. This might include the CEO,
chairman, chief operating officer, chief financial officer and the next-highest
management tier of a firm, such as President, Senior Vice President and Vice
President. Such a definition, which is expected to capture the dominant coalition of
the ‘upper echelons’ of the sample firms, has been applied in other research
concerned with strategic actions (Carpenter and Fredrickson 2001) and entrepre-
neurial firm performance (Roure and Keeley 1990). Thus, we follow this common
practice in this study.
Solo founder/founding team: We use a dummy variable to indicate whether a
startup in the sample is founded by a single founder or by a team, which is coded ‘1’
if it is founded by more than one founder and ‘0’ otherwise. While Eisenhardt and
Schoonhoven (1990) use the number of founders of measure founding team size, our
interest here is not to ascertain the quantitative effect of the marginal contribution of
each founder, but rather the qualitative difference between team-based founding and
solo-founder founding in terms of valuation. A qualitative variable is better suited
for our research purpose here.
Team completeness: As discussed earlier in this section, depending on the specific
situation, key positions in the TMT of a new venture may include: (i) CEO/
President, (ii) VP of marketing/sales/business development, (iii) VP of engineering/
technology, (iv) VP of finance/controller and (v) VP of operation/production/
manufacturing (for manufacturing ventures). We use a dummy variable to capture
the completeness of the TMT, which is coded ‘1’ if all of the above positions were
filled at the time of the financing, ‘0’ otherwise. To make sure the coding is accurate,
following Gompers (1999), we also check whether any new positions were filled after
the current financing round, as venture capitalists routinely assist in executive
recruitment for their portfolio companies.
Network size. Following the conventional practice in network literature,

network size is measured by a direct count of the number of alliance partners a
new venture has before the time it received finding from the venture capitalists,
which include formal partners for all purposes. There is a concern about possible
endogeneity problem on the effect of alliance partners. Our theoretical prediction
is that the alliance partners add value to a new venture, thus, venture
capitalists should value it accordingly. However, the causality may also run the
other way. It may be because a new venture is highly valued by venture
capitalists, it attracts alliance partners. Obviously, there is a potential endogeneity
problem between alliance partner and firm valuation. By excluding alliances
formed after the financing round, we expect this potential problem can be
partially mitigated.
Control variables
Valuating a startup company, or any company, is a complicated task and a
myriad of factors may affect the exact valuation. Some of these factors are
beyond the scope of our theoretical framework. We need to control for the effects
of these factors to avoid making spurious conclusions about our theoretical
variables. Thus, we include various control variables in the model, which include
financial market, industrial and firm-specific factors. The measurement of these
items is straightforward and objective and also follows the established practice in
the relevant literature. Further, all measurements (except firm-level control
variables) are taken directly from their respective data sources, which have
already been calculated.
Previous research finds that movements in the public financial market affect
activities in private financial market. For example, Gompers and Lerner (1999) find
that every doubling of capital infusion into the public capital market is associated
with 26% increase of average valuation in the venture capital market. To control for
this effect, we include the SBF 250 index in the model.
For industry level factors, we include market size and industry profitability as
control variables. Market size is measured by the annual revenue of the industry
defined at five-digit NACE level, as it is the standard way the Euronext Paris
reports the data. While there are several ways to measure profitability, we elect to
use the industry return on investment as the measurement. We also control for
several firm level variables, namely, firm age and firm development stage at the
financing round, and whether the firm is a pure e-commerce firm. Labeled ‘Age’
in the model, firm age is measured by subtracting its founding date from its
financing date and its unit is ‘month’. Firm Developmental Stage is coded as a
categorical variable, coded ‘71’ for ‘seed stage’, ‘0’ for ‘startup stage’ and ‘1’ for
‘first stage’. We use a dummy variable to code whether a firm is a pure dot.com
firm, which is coded ‘1’ if the firm’s main business is mainly conducted through
the Internet and ‘0’ otherwise. Table 1 summarizes the measurements of these
variables.
Model estimation and descriptive statistics

Summarizing the discussions so far, the equation below represents the whole model
to be estimated in the empirical analyses:
Venture Capital 163
Table 1. Summary of variables and measurements.
Variable Sign Measurement

Pre-money valuation Dependent variable Announced valuation of company –
amount invested
Industry structure
Differentiation (H1) þ Industry advertising expenditure/
industry total sales
Industry growth (H2) þ Industry sales in year T/industry sales
in T7l
Founder/TMT
Industrial experience (H3) þ The sum of years the founder(s)

worked in the same industry
Management experience (H4) þ The sum of number of years
founder(s) worked in top
management positions
Startup experience (H5) þ Dummy variable, with ‘1’ indicating
‘have’ and ‘0’ ‘no’
Solo/team dummy (H6) þ Dummy variable, with ‘1’ indicating
founded by a team; ‘0’ otherwise
TMT completeness (H7) þ Dummy variable, with ‘1’ indicating
all key positions are filled; ‘0’
otherwise
Social network
Network size (H8) þ The direct count of the number of
alliance partners
Control variables
Market size The total revenue of an industry
defined at five-digit NACE
Profitability The ROI of an industry defined at
five-digit NACE
Stock index The close points of the SBF 250 index
at the financing date
Firm age The time difference between founding
date and financing date, in unit of
‘month’
Developmental stage Categorical variable, coded ‘71’ for
‘seed stage’, ‘0’ for ‘startup stage’
and ‘1’ for ‘first stage’
Dotcom dummy Dummy variable, coded ‘1’ for pure
Internet business, ‘0’ otherwise
Logðpre-money valuation of a new ventureÞ ¼ a þ b1 ðAdsalesÞ

þ b2 ðR&D salesÞ
þ b3 ðIndustry growthÞ
þ b4 ðIndustry experienceÞ
þ b5 ðManagement experienceÞ
þ b6 ðStartup experienceÞ
þ b7 ðTeam-foundingÞ
þ b8 ðTeam completenessÞ
þ b9 ðNetwork sizeÞ
þ b1k ðVector of controlsÞ
where a is the intercept, b1–b9 are the coefficients of the theoretical variables to be
estimated, b1–k represent the coefficients of the control variables to be estimated,
where k equals to 6. Substantial firms received multiple early-stage financings in the
sample, with a minimum of one and maximum of four. Including repeated
observations on the same firm in the regression model is likely to violate the standard
assumption of independence from observation to observation in regression models.
The interdependence of observations may lead to firm-specific heteroscedasticity and
autocorrelation. If these problems exist, the coefficients estimated by ordinary least
square (OLS) are inefficient. We went through two procedures to diagnose any
potential violations of the classic assumptions. To diagnose potential heteroscedas-
ticity problem, we follow Greene (2007) and examine the data by the Modified Wald
test for heteroscedasticity. The results show that the variances of the dependent
variables are not constant (heteroscedastic) across panels. To correct this
heteroscedasticity problem, we estimate the model with random-effect OLS
estimator, assuming heteroscedasticity across panels. By choosing a generalized
least square (GLS) estimator with assumed heteroscedasticity, the variances of the
error terms are allowed to vary from panel to panel and the effects of those
contemporaneous variances are taken into account in the intercept term. To ensure
that we make a correct choice of the random-effect estimator, we also conduct a
Hausman specification test and the result confirms that random-effects model is
appropriate for our data. Finally, we use the Breusch–Godfrey Lagrange multiple
test to detect possible autocorrelation problem. The result indicates that there is no
serious autocorrelation in the error terms, probably because the time waves are quite
limited.
Table 2 reports the means, standard deviations and minimum and maximum of
all variables used in the model. The 102 new ventures received a total of 184 rounds
of early-stage venture capital financing during the sampling period. There is
sufficient variability among all the variables in the model. The average valuation of
the young firms across all financing rounds is around e6.4 million. The average firm
age at the financing round is around 15 months, with a minimum of 3 months and
Table 2. Descriptive statistics.
Variable Mean SD Min Max

Log (pre-money valuation) 3.804 0.511 2.107 5.294
Advertising intensity 3.694 2.562 0.180 11.700
R&D intensity 17.896 9.229 0.000 49.546
Industry growth 41.143 31.466 729.350 221.915
Industry experiences 0.932 0.252 0.000 1.000
Management experiences 0.618 0.487 0.000 1.000
Startup experiences 0.456 0.499 0.000 1.000
Team-founding 0.750 0.434 0.000 1.000
Team completeness 0.250 0.434 0.000 1.000
Network size 0.479 0.843 0.000 8.000
Market size 85,570.7 135,476.1 3,010.0 817,223.8
ROI 73.378 16.181 754.329 77.864
SBF 250 index 3597.6 475.7 2709.1 4354.4
Firm age 15.459 13.645 3.000 84.000
Firm stage 0.415 0.853 71.000 1.000
Dotcom dummy 0.229 0.421 0.000 1.000
Venture Capital 165
maximum of 84 months. The increased magnitude of team-based founding activities

indicates increased complexity and competition over the last decade. While most
founders have had relevant experiences in related industry (93%) and executive
management positions (62%) before founding their current firm by the time of
financing, only 25% of the sample firms have a complete TMT at the financing
round.
Results and discussion

Main statistical results
The Appendix reports the bivariate correlation matrix of the variables used in the
model. The bivariate correlations between the dependent variable and a number of
independent variables are largely consistent with the theoretical predictions. Five of
the nine theoretical variables are significant at 1% and in the predicted direction. The
matrix also indicates that some of the independent variables are significantly
correlated, but significant correlation between individual variables does not
necessarily mean severe multicollinearity for the whole model. Indeed, the average
variance inflating factor (VIF) of the model is only 1.23, which is far below the
conventional threshold level of 20. Thus, in this case, according to Kutner,
Nachtsheim, and Neter (2004), there is no multicollinearity problem in the data.
Table 3 reports the estimates from the random-effects GLS estimation on pre-
money valuation of the new ventures in the sample. The coefficients are obtained
after correcting heteroscedasticity across panels and controlling some confounding
effects.
Model 1 is the baseline model, which contains the control variables only. Model 2
tests the industry structure effects, Model 3 tests the firm resources effects and Model
4 tests the effects of external network. Model 5 is the full model, containing all the
variables. Except a small variability, the estimates are quite consistent across all the
models. Therefore, we report the results mainly from the full model.
Since our primary interest at this stage of the study is to establish a theoretical
linkage (and substantiate it with empirical evidences) between venture capitalists’
valuation of a new venture and the theoretical variables derived from the theoretical
framework, not to estimate the exact quantitative coefficients of these variables, we
focus our discussion on the general relationships, not on individual coefficients.
Industry structure effects

By employing the industry organization perspective of industry stricture on firm
performance, we proposed that venture capitalists consider the characteristics of
industry structure when setting a value to a new venture. We include three
measurements of the two industry structural variables to capture the industry
structural effects on new venture valuation and each of them are hypothesized to be
positively related to pre-money valuation of a new venture. Consistently, both
measures of product differentiation (R&D intensity ratio and advertising intensity)
are highly significant and in the predicted direction. The results show that new
ventures in highly differentiated industries (both perceptual and innovative
differentiations) do receive higher valuation from venture capitalists. Thus, H1
receives support in both Model 2 and Model 4. H2 hypothesizes that industry growth
should be positively related to the valuation of new ventures by venture capitalists.
166
Table 3. Log of pre-money valuation of new ventures, in thousand e.
Dependent variable Model 1 Model 2 Model 3 Model 4 Model 5

Industry structure
Advertising intensity 0.0059g (0.003) 0.005232 (0.0037)b
R&D intensity 0.0051 (0.0006)a 0.02429 (0.00097)b
Industry growth 0.0006 (0.0002)a 0.000558 (0.0003) g
Founder effects
Industry experiences 0.033387 (0.0467) 0.079426 (0.0258)a
Management experiences 0.10028 (0.0189)a 0.101188 (0.019)a
Startup experiences 0.04083 (0.0139)a 0.05895 (0.0149)a
TMT effects
Team founding 0.1345 (0.0165)a 0.09792 (0.021)a
Team completeness 0.18667 (0.0252)a 0.14411 (0.019)a
Network effects
Network size 0.14323 (0.0107)a 0.10101 (0.0107)a
Control variables
Market size 2e-7 (9e-8)b 5e-5 (1e-5)a 3.8e-7 (9.79e-8)a 3.26e-7 (6.4e-8)a 4.7e-5 (1.7e-5)a
T. Miloud et al.
ROI 0.00104 (0.0004)b 0.0014 (0.00037)a 6.4e-7 (0.0004)a 9.57e-4 (2.85e-4)a 0.0034 (0.00003)b
Stock index 0.00044 (0.00003)a 0.0004 (0.00003)a 3.8e-4 (3e-5)a 3.329e-4 (2.56e-5)a 0.00034 (0.00003)a
Firm stage 0.0067 (0.0006)a 0.0065 (0.0005)a 6.7e-3 (6e-4)a 6.04e-3 (5.29e-4)a 0.00549 (0.00057)a
Firm stage 0.153 (0.009)a 156 (0.009)a 0.1228 (8.7e-3)a 0.1246 (7.1e-3)a 0.112514 (0.008)a
Dotcom dummy 0.09 (0.012)a 0.145 (0.0126)a 0.123 (0.0253)a 3.44e-2 (2.14e-2)b 0.09983 (0.02)a
Constant 3.159 (0.03)a 2.993 (0.037)a 2.948 (0.055)a 3.227 (0.026)a 2.8624 (0.037)a
N 184 184 184 184 184
Wald w2 1760.3(6) 5928.9(9) 2932.5(11) 5922.8(7) 5778.1(15)
Log likelihood 751.98457 750.49872 735.8 732.3786 727.28336
Prob4w2 0.000 0.000 0.000 0.000 0.000
Notes: (i) Coefficients are standardized; (ii) standard error in parenthesis; (iii) coefficients with ‘a’, ‘b’ and ‘g’ are, respectively, significant at 1, 5 and 10% level; (iv) Number
in superscript in the Wald w2 statistics is the degree of freedom for the test.
Venture Capital 167
As predicted, results from Model 2 and Model 4 confirm that the industry growth is
indeed positively and significantly related to the pre-money valuation of new
ventures. These results render strong support for the hypothesis that industry
structure partially determines the startup valuation by venture capitalists. They are
also consistent with McDougall, Robinson and DeNisi’s (1992) study which
concluded that the industry structure influences the performance of new businesses
and the Zider’s (1998) finding that venture capitalists give higher valuation to new
ventures in growing industries.
Entrepreneurial resources
Subsequently, we hypothesized that venture capitalists consider the characteristics of
the founder(s) and his management team when valuating a new venture. More
specifically, we proposed that the quality of the entrepreneur and the entrepreneurial
team should be positively related to the valuation of his new venture. Consistent with
the theoretical prediction, all the five subhypotheses about the founder/entrepreneur
and his top management receive strong support.
In terms of founder experiences, the results show that venture capitalists value a
new venture significantly higher if its founder(s) has (i) relevant industry experience
(H3), (ii) relevant managerial experiences (H4) and (iii) startup experiences (H5)
before he founded his current new venture than those without such valuable
experiences. Thus, all hypotheses on the three important experiences measuring the
quality of the founder received strong support. The only exception is for ‘industry
experiences’ in Model 3 with a significance level around 10%, but this may also be
due to a change in the covariance structure in the model.
Regarding the hypotheses on entrepreneurial team, new ventures with a
complete management team are valued significantly higher than those without one
(H7), so are new venture founded by a team of entrepreneurs rather than a solo
founder (H3). Hence, these findings give strong overall support for proposed
relationship that the characteristics of the entrepreneurial team influence new firm
valuation. These findings are also consistent with those from the venture capitalist
screening and selection literature that focuses on the ‘GO/NO-GO’ decision
(MacMillan, Siegel, and Narasimha Subba 1985; Zacharakis and Meyer 1998) as
well as Franke et al. (2008) that find experience at the individual level, the
existence of an entrepreneurial team, the qualifications of team members, the
completeness of the team and its cohesion are important criteria for venture
capitalists’ valuation.
External ties
Consistent with previous findings of Stuart, Hoang, and Hybels (1999) on the public
stock market’s valuation of new ventures on the IPO market, the size of the new
venture’s network (as measured by the number of alliance partners) is significantly
and positively related to its valuation by venture capitalists. This finding supports H8
and is consistent with the literature on the benefits of alliances, particularly with the
work of Zheng, Liu, and George (2010) showing that the inter-organizational
network of a startup, in conjunction with its ability to innovate, influence its
performance and its assessment by venture capitalists.
It is worth noting that the above results are obtained after controlling for
potential confounding effects of other factors from financial market, industry and
firm age, stage of development and whether the new venture is a dotcom, all of which
are highly significantly related to the valuation and in the positive direction.
Relative importance of the theoretical perspectives

As discussed in section 5.1 at the beginning of this section, repeated observations
over the same firm excludes the use of OLS estimator to estimate the models. To
overcome the heteroscedasticity arisen from repeated observations, we use a
random-effect GLS estimator to estimate the models. While the GLS estimator is
more efficient and has other benefits, one of the drawbacks of the GLS model is that
it only reports the Wald Chi-squared test as an indicator of the model’s overall fit. It
does not report the R-squared coefficient. Thus, we cannot determine the relative
explanatory power of the models by just looking at the magnitude of the overall
model statistics. Fortunately, a little exploration helps solve this challenge. We know
Chi-squared distribution is the sum of n-squared standard normal distributions,
where n is the number of degrees of freedom. Like the standard normal distribution,
the Chi-squared distribution has several nice features, such as additivity and
divisibility. Following Greene (2007), a feature of particular usefulness to our task
here is that the ratio of two independent Chi-squared variables has the F
distribution. Therefore, we can compare the relative explanatory power of two
models by dividing the two Chi-squared statistics, which is an F distribution. Table 4
reports the F statistics.
From the F-statistic value in Table 4, it is clear that there is no significant
difference among the three theoretical perspectives in terms of their explaining power
of new venture valuation. In other words, it seems that venture capitalists weigh
these factors equally in their valuation. However, such a conclusion may be
premature as the models estimated are not fully specified as many other important
variables from each theoretical perspective are not included in the model.
To further explore this issue, we did another F-test between all the industry
variables (including the three theoretical variables – differentiation and growth, and
two control variables – market size and profitability) and all the firm-level variables
(including all the five theoretical variables and three firm level control variables –
age, stage and dotcom dummy). The value of the F test – F(8/5) – is 4.6962, with a p-
value of 0.0526, which indicates that the difference is still only marginally significant.
Therefore, the relative importance of the respective theoretical perspectives is not
conclusive at this stage.
Table 4. Relative importance of the theoretical perspectives.
Industry structure Founder/team Network

Wald w2 5928.94 2932.5 5922.8
Degree of freedom 9 11 7
Industry organization/ Resource-based Network/industry
resource-based view view/network organization
F-statistic 2.021803922 0.495120551 0.9989644
p-value 0.1349 0.857 0.4885
Venture Capital 169
Regardless of the relevant importance of the three perspectives, we conclude that

all three dimensions of strategic variables – industry, entrepreneurial resources and
network – contribute positively to firm valuation by the investor. These findings
imply that there exists an alternative route to startup valuation through an
assessment of easily observable strategic variables and render the valuation process
less dependent of unreliable financial calculations. Even this is a strong finding based
on data from actual valuations by venture capitalists, further research is required in
order to turn these findings into viable practical tools for entrepreneurs and
investors.
Implications for management and limitations

Our findings suggest several implications for entrepreneurs and investors. Firstly,
compared with the venture capital valuation practice, the proposed approach may
lead to the development of a more accurate method for valuating new ventures.
Barry (1994, 3) finds that more than one-third of the investments made by venture
capitalists result in tosses and a sizeable fraction results in total loss of the entire
original investment ‘often after years of waiting and countless hours of handholding
by the venture capitalists’. Moreover, over-valuation of investment deals contributed
greatly to the gigantic loss during the ‘dotcom bubble’. More accurate valuation
methods can help mitigate this investment ‘herding’ and over-valuation problems in
the venture capital industry.
Secondly, as illustrated by Gompers (1999), the venture capital method is
essentially an internal-oriented, ‘rule of thumb’ method, which is inaccurate and
unjustifiable. Unjustifiable low valuation is one of the major sources of venture
capitalist–entrepreneur conflict. The proposed approach may help venture capitalists
improve both accuracy and defensibility of their valuation and thereby facilitate VC–
entrepreneur collaboration and improve productivity as entrepreneurs are better able
to adapt their business plan and actual operations to the requirements of venture
capital investors. One of the major strengths of our approach is that it is based on
input that is readily available at the time of the negotiations. Therefore, the proposed
approach can not only increase accuracy and soundness of the valuation, but it is
also likely to facilitate collaboration and reduce conflict between entrepreneurs and
venture capitalists (Zacharakis, Erikson, and Bradley 2010). Entrepreneurs will be
able to produce the required information and to understand the way venture
capitalists use the information. Furthermore, a more accurate valuation of an
investment target can also help the venture capitalists to defend their decisions in
cases of litigation by general partners or other stakeholders.
This study uses an exploratory approach and the objective is to understand the
influence of explanatory variables identified in the strategic management literature
from the three fields of research on the valuation of startups. However, the study
also presents some limitations inherent to this approach. First, our theoretical
approach takes into consideration the complementarity of the industrial economics
field, the resource-based view and the network approach. One weakness of this study
is that it is limited to a few variables from these areas of research. Especially,
variables from the network literature could extend the model developed in this
article. There are also other dimensions of variables that should be considered to be
entered into the model. One interesting venue would be to incorporate the
characteristics and cognitive abilities of venture capitalists, although such
information would be difficult to find and operationalize. Another promising venue

with less methodological issues would be to incorporate technology variables. We
know from previous research that new ventures with different technologies face
different challenges in terms of market entry and that it influences their profit
potential and ability to survive (Aspelund, Berg-Utby, and Skjevdal 2005). All these
effects are well known by venture capitalists and it is likely that they are taken under
consideration in new venture valuations. Finally, our study is limited in terms of its
time period and country (France).
Hence, multiple paths exist to extend this strand of research on new venture
valuation: (i) test our model on a new startup through a clinical study incorporating
more network effects, technological and venture capitalist characteristics, (ii)

conduct an exploratory study to know all the limitations of the model, (iii) the use
in combination approach for real options and strategic approach for the evaluation
of a startup and (iv) extend the observation period and have a sample of European
startups in order to broader conduct a study comparative.
Conclusions
How to value a company is traditionally a finance topic; however, most financial
valuation methods were developed for well-established companies and especially for
companies in the more efficient public capital market. As demonstrated by Waldron
and Hubbard (1991), the traditional financial methods yield valuations with large
variability. Against such a backdrop, this article leverages established theories in
strategic management to develop an integrated framework and use those input
variables important to firm performance to directly predict the valuation of an early-
stage new venture. Presumably, when it is difficult to value a young firm based on
output (e.g. future cash-flows), pricing it based on inputs (e.g. entrepreneur, industry
attractiveness, etc.) may be a better alternative than ‘pure guess’. Though tentative,
the results from the empirical analyses support the central propositions that strategic
management theories are useful in explaining the valuation of early-stage new
ventures. This empirically substantiated linkage between established strategy
theories and new venture valuation practice makes it possible to develop a
systematic approach to identify and measure factors important to new venture
valuation. Such findings hold a lot of promise for both theory building and practice
in entrepreneurial financing.
For Dittmann, Maug, and Kemper (2004), the use of multiple valuation methods
significantly reduces the failure rate of funding agreements between venture
capitalists and entrepreneurs. Venture capital investors that base their investment
strategy on core business values and adopt a long-term vision seem to have an
advantage over those who engage in short-term subjective bargaining strategies. The
use of valuation criteria from the strategic management provides a long-term vision
of both the venture and of the funding provided after the venture valuation.
Gompers and Lerner (1999) argue that the venture capital has been an important
factor behind both entrepreneurship and innovation in US economy for the past 30
years. Despite its critical importance in venture capital financing, how to value a new
venture is seldom touched in the extant literature and only a handful papers are
available. Moreover, even the few existing studies are clinical and descriptive in
nature. This study goes beyond simple descriptive statistics and fills this noted gap in
the research literature. We leverage well-established theories in strategic
Venture Capital 171
management to develop an integrated framework to study new venture valuation by

venture capitalists. Extending the axiom definition of investment value in the finance
literature that the economic value of any asset is the value of its future cash flows,
which is the measure of firm performance, we propose that those factors that have
been identified as important to firm performance in the strategic management
literature should be positively related to the valuation of a new venture. Therefore,
venture capitalists should take these factors into consideration when they value a
new venture in their investment decision process.
From this central proposition and grounded in the three mainstream strategy
theories, eight hypotheses were developed on the effects of industry structure,
founder and TMT, and external relationships of a new venture on its valuation by
venture capitalists. Robust statistical analyses based on a large sample of 184 early-
stage financing rounds on 102 new ventures provide support for almost all of the
hypotheses, which indicate that the strategic management theories are indeed useful
to explain venture capitalists’ valuation of early-stage new ventures. This empirically
supported linkage between strategic management theories and new venture valuation
practice should hold some promise for exploring complementary valuation methods
for new ventures, especially when traditional valuation approaches are not reliable
due to lack of accounting information.
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Appendix 1. Correlation matrix of control variables
Variable (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16)
(1) Log 1.000

(valuation)
(2) Advertising 70.0344 1.000
intensity
(3) R&D 0.0572 0.2142a 1.000
intensity
(4) Industry 0.0823 0.1625a 0.1059 1.000
growth
(5) Management 0.1111 0.0477 0.0544 0.0558 1.000
experiences
(6) Management 0.1529a 70.0721 70.0227 0.0160 0.1737a 1.000
experiences
(7) Startup 0.1446a 70.0351 70.0231 70.0986 0.1055 0.3678a 1.000
experiences
a
(8) Team- 0.1729a 0.0090 70.0291 70.0212 0.2231 0.1048 0.1602a 1.000
founding
T. Miloud et al.
(9) Team 0.3124a 70.1276 0.0567 0.0249 0.0203 0.1328 0.0852 0.0667 1.000
completeness
(10) Network size 0.3570a 70.0157 70.0349 0.1093 0.0421 0.0455 0.0680 0.0868 0.2925a 1.000
(11) Market size 0.1539a 70.1230 70.2765a 0.2346a 70.0926 0.1409a 0.0781 70.0240 0.0547 0.0893 1.000
a
(12) ROI 70.0520 0.0439 70.0883 70.1690 0.0150 70.0511 0.0348 0.0278 70.0703 70.0450 0.0014a 1.000
a
(13) SBF 250 0.2945a 70.3503a 0.0422 0.0145 0.0726 0.0861 0.0287 0.0371 0.2131 0.2077a 0.2099 70.2046a 1.000
index
a a a a
(14) Firm age 0.2923a 0.0582 0.1436 0.1595 0.0134 70.0650 70.0724 70.0229 0.2557 0.2647 0.0487 70.1157 0.1082 1.000
(15) Firm stage 0.3436a 0.0004 70.0245 70.0450 0.0762 70.0006 0.0605 0.0658 0.1894a 0.2233a 0.0459 70.0941 0.1983a 0.2698a 1.000
a
(16) Dotcom 0.1126 0.000 70.2929 70.0517 70.0759 70.0745 0.1186 0.0242 0.0242 0.1546a 0.0651 0.1219 70.0382 70.0040 0.0629 1.000
dummy
Note: Coefficients with ‘a’ are significant at 1% level.

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Startup valuation by venture capitalists: An empirical study

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Tarek Miloud Arild Aspelund

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Startup valuation by venture capitalists: an empirical study

Department of Finance, Chambery Business School, Savoie Technolac,

Le Bourget du Lac Cedex, France

How to value a new venture is critical in entrepreneurial ﬁnancing. This article

*Corresponding author. Email: tmiloud@gmail.com

ISSN 1369-1066 print/ISSN 1464-5343 online

Theoretical framework and hypotheses

environment in which a ﬁrm competes. It identiﬁes the structural conditions under

Industry organization and startup valuation

performance. Extrapolating from these empirical results on ﬁrm performance, we

H1 – The degree of product diﬀerentiation of an industry is positively related to the

Entrepreneurial resources and startup valuation

(2) Top management experience: The literature on top management experience

Top management team

Completeness of management team. Similarly, the completeness of the management

External ties and startup valuation

Data sources and case selection

(deﬁned at ﬁve-digit NACE code) in the 7-year period.

advertising intensity ratio as a measure of the perceptual aspect of product

Network size. Following the conventional practice in network literature,

Model estimation and descriptive statistics

Table 1. Summary of variables and measurements.

Variable Sign Measurement

Industrial experience (H3) þ The sum of years the founder(s)

Logðpre-money valuation of a new ventureÞ ¼ a þ b1 ðAdsalesÞ

Table 2. Descriptive statistics.

Variable Mean SD Min Max

maximum of 84 months. The increased magnitude of team-based founding activities

Results and discussion

Industry structure eﬀects

Table 3. Log of pre-money valuation of new ventures, in thousand e.

Dependent variable Model 1 Model 2 Model 3 Model 4 Model 5

Relative importance of the theoretical perspectives

Table 4. Relative importance of the theoretical perspectives.

Industry structure Founder/team Network

Regardless of the relevant importance of the three perspectives, we conclude that

Implications for management and limitations

information would be diﬃcult to ﬁnd and operationalize. Another promising venue

more network eﬀects, technological and venture capitalist characteristics, (ii)

management to develop an integrated framework to study new venture valuation by

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(1) Log 1.000

Note: Coeﬃcients with ‘a’ are signiﬁcant at 1% level.

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