Ben Gilbert: evaluation

Transcript context

…And then we're like, well, that founder and that idea is worth $20 million. It's so funny to me. People think it's complete voodoo math how venture capitalists come up with with valuations. This is where I think that Michael's comment and his thoughts on this make a lot of sense, because once you admit that there is no DCF and you stop trying to say, in what world is that worth $20 million, or $10 million, or $70 million at an idea stage, which we've seen recently? If you're willing to let that go, meditate, take your deep breath and say, okay, well, how do we price this thing then if it's not based on classic investing DCFs? Really, venture capital in the early stage is not at all cash flow–based investing. It's actually options investing. As you sort of think about it that way, the world starts to make more sense, because how do you value an option? When you look at the range of potential outcomes, the probabilistic likelihood of that option and the entire range of outcomes, which is actually what venture capitalists are doing, whether they're cognitively thinking about it that way or not, you're basically saying, what's the chance that this is a billion dollar company, or $100 billion company, or a zero? Of course, this leads to the idea that you need diverse portfolios rather than just investing in single large companies, because this range of potential outcomes is so wide that you need to find ways to sort of smooth that risk while still benefiting from the potential of an asymmetric return. It also completely explains why venture capitalists are so obsessed with TAM. It was one of the things when I first got into the industry. I was like, why is everybody care so much about the TAM? Aren't there other aspects that you should care about? What's most sensitive to the valuation of the option is the magnitude of the outcomes that are possible. You can then debate the probable weighting of it. But the higher the magnitude of the outcomes, the more valuable the option is going to be.…

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