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Applying real option approach for startup valuation by venture capitalists in first round of financing

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Abstract

Startup valuation in venture capital investment has always been an important issue in negotiations between entrepreneurs and venture capitalists. Results of conducted researches on startup valuation have revealed difficulties and complexities in determining entrepreneurial projects value, especially in early stages of their development. It is due to the existing challenges and high degree of uncertainty about their future. Using real options analysis in this research, a new approach for determining startup companies’ value, considering uncertainties in the first round of financing and flexibility available to venture capitalists in making their investment decision was presented. Due to lack of analytical solution for the developed approach, the numerical method of Monte Carlo least squares simulation (Longstaff-Schwartz) was used to solve it, where percentage of ownership of the entrepreneur and venture capitalist was determined based on the results of the simulation. In addition, by comparing the results of the proposed approach with results of the net present value method, as it was emphasized in the literature, it was concluded that traditional methods do not have the required credit for valuing in early stage companies. Finally, there were suggestions for developing the approach under competitive interactions or developing it for other stages of investment.

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References
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Management Research in Iran
Volume 22, Issue 3
December 2018
Pages 1-27
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