How Do Venture Capitalists Value the Companies?

Superior Management, A Large Market, and Unique Products Create Value

One of the most often asked questions by entrepreneurs relates to how VCs calculate the equity share they demand in exchange for the funds they invest. How do they arrive at 20%, or 50%? We asked Venture Capitalists to rate a number of factors they use to value the investment, with a rating of 5 being the most important, and 1 being the least important.

Quality of management: 4.5
Size of the market: 3.8
Product qualities:(uniqueness, brand strength, patent protection) 3.7
Rate of market growth: 3.5
Competition: 3.5
Barriers to entry: 3.4
Stage of development of the company: 3.2
Industry the company is in: 3.0

Quality of management was emphasized by the VCs to the extent that 7 out of 10 gave it a rating of "5", and nearly 9 out of 10 gave it at a 4 or 5. There were a few mavericks among those surveyed, however: 7% gave management quality an importance rating of only 1 or 2.

No other factor came close in importance. The next most important, size of the market, was given a rating of 5 by only 30% of the respondents, followed by product qualities, which received a 5 from about one out of four respondents.

Note that all of the factors received an average score of 3 or higher. All of these factors were viewed as significant, and entrepreneurs should take care to clearly articulate each of them to investors.