The venture capital method worked on one Series A cheque: from exit value to target multiple, then the step most people skip, the dilution still to come.
The VC method values a startup backwards from its exit: post-money = exit value × retention / target multiple, and pre-money is post-money less the new cheque. On an illustrative company expected to sell for 200 million in five years, a 10x target and 32 per cent of dilution still to come, a 5 million Series A buys 36.8 per cent at 13.6 million post-money, 8.6 million pre-money. Leave out the dilution and the same arithmetic says 15.0 million pre, and the cheque returns 6.8x instead of 10x.
Worked in full in The Venture Capital Associate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Early-stage companies have no earnings to put a multiple on and no cash flows worth discounting, so investors price them from the end. The method needs four inputs: what the company could be worth at exit, when, the multiple the investor needs on a winner, and how much of the stake later rounds will take. Each is a judgement; the arithmetic that joins them is not, and it is where term sheet negotiations are usually lost.
| Input | Value |
|---|---|
| Series A investment | 5,000,000 |
| Revenue in the exit year | 40,000,000 |
| Exit multiple of revenue | 5.0x |
| Years to exit | 5 |
| Target multiple on this cheque | 10.0x |
| Later rounds before exit (dilution each) | 20%, 15% |
Exit value = 40,000,000 × 5.0 = 200,000,000. In practice this is the most argued number in the model: the revenue forecast comes from the company, the multiple from comparable exits, and both are optimistic in a pitch deck. Use an exit value you would defend at investment committee, not the founder's.
Ownership at exit = investment × target multiple / exit value
5,000,000 × 10 / 200,000,000 = 25.0 per cent. A 10x target over five years is an IRR of 58.49 per cent: =10^(1/5)-1.
The naive version stops here: 25.0 per cent for 5 million is a post-money of 20.0 million and a pre-money of 15.0 million. That is only right if the company never raises again, which a Series A company almost always does.
Two further rounds are expected, diluting existing holders by 20 and 15 per cent. The stake the investor keeps is the product of what each round leaves, not the sum of what each takes:
Retention = (1 − d1) × (1 − d2) = 0.80 × 0.85 = 0.68
Ownership at entry = 25.0% / 0.68 = 36.76 per cent. Post-money = 5,000,000 / 36.76% = 13,600,000. Pre-money = 13,600,000 − 5,000,000 = 8,600,000. In one Excel cell: =200000000*0.8*0.85/10-5000000.
Check it forwards: 36.76 per cent diluted by 32 per cent is 25.00 per cent of 200 million, 50,000,000, which is 10.00x the cheque. The same answer falls out of the discount-rate form: 200 million discounted five years at 58.49 per cent is 20,000,000, and 68 per cent of it is 13,600,000.
| Basis | Pre-money | Stake at entry | Stake at exit | Proceeds | Multiple |
|---|---|---|---|---|---|
| Dilution ignored | 15.0m | 25.0% | 17.0% | 34m | 6.8x |
| Dilution included | 8.6m | 36.8% | 25.0% | 50m | 10.0x |
Pricing on the naive basis pays 74.4 per cent more for the company, 6.4 million of pre-money, and turns a 10x underwriting into 6.8x, a 46.7 per cent IRR instead of 58.49, with nothing in the business having changed. The dilution was in the plan from the start; it was just not in the formula.
A 36.8 per cent stake for a Series A is high. That is information, not an error: if the round cannot be done near 8.6 million pre-money, either the exit case is too small, the target too high, or the company will raise more later than assumed. The method tells you which number has to move. Later-stage investors run the same three lines with a lower target and less dilution ahead; the growth equity version at a 3x target shows how much the cap moves when later rounds take less.
| Target multiple | IRR over 5 years | Exit 120m | Exit 200m | Exit 300m |
|---|---|---|---|---|
| 5x | 38.0% | 11.3 | 22.2 | 35.8 |
| 10x | 58.5% | 3.2 | 8.6 | 15.4 |
| 15x | 71.9% | 0.4 | 4.1 | 8.6 |
| 20x | 82.1% | −0.9 | 1.8 | 5.2 |
The valuation is far more sensitive to the inputs than the inputs look. Moving the exit from 200 to 300 million, half as much again, raises the pre-money by 79 per cent, from 8.6 to 15.4 million, because the cheque is a fixed deduction. A negative figure means no price works: at a 20x target the investor would need more than the whole company for a 120 million exit.
| Retention | Post-money | Pre-money | Stake at entry |
|---|---|---|---|
| 100% | 20.0m | 15.0m | 25.0% |
| 80% | 16.0m | 11.0m | 31.2% |
| 68% | 13.6m | 8.6m | 36.8% |
| 60% | 12.0m | 7.0m | 41.7% |
| 50% | 10.0m | 5.0m | 50.0% |
The VC method is three lines: exit value, ownership needed at exit, ownership needed today. The third line is the one that matters, because a Series A investor who prices on today's stake is buying a share that later rounds will cut by a third. On this case that is the difference between 8.6 and 15.0 million pre-money. The Venture Capital Associate puts the return model next to the fund it must serve, and the free workbook for this case runs the dilution and reserve arithmetic behind it; for the fund-level version of the same question, see what exit value returns a venture fund.
Illustratively, 10x to 30x at seed and 5x to 10x at Series A or B, because the target has to cover the companies that fail. A 10x target over five years is a 58.49 per cent IRR, but if only one investment in three succeeds the portfolio earns about 3.33x. The target multiple is a hurdle for a winner, not the return the investor expects on average.
It is a one-cash-flow DCF: post-money equals the exit value discounted at the target rate for the holding period, times retention. At 58.49 per cent over five years, 200 million discounts to 20.0 million, and 68 per cent retention takes it to 13.6 million. The difference from a DCF is that the discount rate carries failure risk, not just the cost of capital.
Every later round shrinks the stake, so the investor must buy more today to own enough at exit. With 20 and 15 per cent rounds ahead, retention is 68 per cent: 25.0 per cent needed at exit means 36.8 per cent at entry, and the pre-money falls from 15.0 to 8.6 million. Ignore it and the same cheque returns 6.8x, not 10x.
This article is one calculation from The Venture Capital Associate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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