The venture capital method is a valuation approach that starts with a startup's expected value at exit, divides it by the return the investor requires, and adjusts for future dilution to find the most the investor can pay today. It is often used for early-stage companies with little revenue, where discounted cash flow models tend to break down. The output is a maximum post-money valuation and a required ownership percentage, not a precise "true" value.
Definition: The venture capital method values a startup by estimating its terminal (exit) value, discounting that value by a target return multiple or rate, and dividing the investment amount by the result, adjusted for expected dilution, to derive the required ownership and implied post-money valuation.
A banker values a company forward, from the cash it makes today. A venture investor values it backward, from the exit it might reach one day.
The approach was formalized in a 1987 Harvard Business School note, "A Method for Valuing High-Risk, Long-Term Investments: The Venture Capital Method," by HBS professor William A. Sahlman and Daniel R. Scherlis. The note describes forecasting a future value (its example uses five years out) and discounting that terminal value back to the present at a high rate, with 50 percent as the illustrative figure.
Why investors use venture capital method valuation
Most early-stage companies have no stable cash flows to discount. The survey of 885 VCs at 681 firms by Gompers, Gornall, Kaplan, and Strebulaev, summarized on the Harvard Law School Forum on Corporate Governance, found that few VCs use discounted cash flow or net present value techniques, that 20 percent do not forecast cash flows at all when they invest, and that cash-on-cash multiples and IRR are the most common metrics.
The VC method matches that reality by asking one practical question: at this price, can this deal return what we need?
It also ties each deal to fund math. Andreessen Horowitz's analysis of Horsley Bridge's historical fund data found that about 6 percent of investments, representing 4.5 percent of dollars invested, generated roughly 60 percent of returns. On that view, each deal needs a credible path to a large multiple, which is what the target return in this method encodes. Our founder guide to seed valuations and venture return math applies the same logic to pricing a seed round.
Venture capital method valuation formula, step by step
- Estimate terminal value. Project a metric at exit (revenue or earnings) and apply a comparable exit multiple. Terminal value = exit-year metric times exit multiple.
- Choose the target return. Express it as a multiple, or convert a target IRR: multiple = (1 + IRR) raised to the number of years. The NBER working paper behind the Gompers survey reports an average required cash-on-cash multiple of 5.5 and a median of 5, and an average required IRR of 31 percent. It also finds that late-stage and larger VCs require lower IRRs, around 28 to 29 percent, while smaller and early-stage funds require more. Many seed investors look for a potential 10x or more on an individual deal, consistent with the paper's finding that early-stage and smaller funds require higher returns, but the number varies by firm and by fund size.
- Calculate the undiluted post-money value. Post-money before dilution = terminal value divided by the target multiple. This is the answer only if the company never raises again.
- Calculate required ownership at exit. Ownership at exit = (investment times target multiple) divided by terminal value.
- Adjust for dilution. Future rounds shrink the stake. Retention ratio = the product of (1 minus dilution) for each future round. Required ownership today, measured before any later round, = ownership at exit divided by the retention ratio.
- Derive the valuation. Post-money today = investment divided by required ownership today. Pre-money = post-money minus the investment.
Throughout, ownership percentages are quoted on a post-money basis for the round being priced, and "ownership today" means the stake the investor buys at closing, before any future round dilutes it.
Illustrative worked example: a seed round
As an illustration, a seed fund is considering a $3M investment.
- Exit assumption: the company reaches $50M in revenue in year 7 and sells at 6x revenue, a terminal value of $300M.
- Target return: 10x on this deal, which is about a 39 percent IRR over 7 years (1.39 to the 7th power is 10.03).
- Undiluted answer (step 3): $300M divided by 10 is a $30M post-money valuation, which would give the fund 10 percent and require no further rounds.
- Ownership needed at exit: ($3M times 10) divided by $300M = 10 percent.
- Dilution: two more priced rounds before exit. Carta's State of Private Markets: 2025 in Review reported that median dilution across seed through Series C rounds fell from about 18 percent to 16 percent over 2025; using 16 percent, the retention ratio is 0.84 times 0.84, or 0.7056.
- Ownership needed today, post-money at closing and before later rounds: 10 percent divided by 0.7056 = 14.17 percent.
- Maximum post-money today: $3M divided by 14.17 percent = $21.17M, so a pre-money of about $18.17M.
Compare that with the market. Carta's March 2026 analysis of early-stage rounds reported a median seed post-money valuation of $24M in Q4 2025, up from $18M a year earlier. At $24M post-money the fund would own 12.5 percent at closing, which is 8.82 percent after the same two rounds of dilution, worth $26.46M at a $300M exit, or 8.82x.
So the math says $21M and the market says $24M. The investor has a few options: accept a lower multiple, negotiate on price, or underwrite a bigger exit.
Sensitivity: the inputs that move the answer
The VC method is only as good as its assumptions, and small changes can swing the result. Holding the $3M check, the 10x target and the 0.7056 retention ratio constant:
| Change | Terminal value | Max post-money today |
|---|---|---|
| Base case (6x revenue) | $300M | $21.17M |
| Exit multiple falls to 4x revenue | $200M | $14.11M |
| Target return falls to 5x | $300M | $42.34M |
| A third round at 16 percent dilution (retention 0.5927) | $300M | $17.78M |
Halving the target return doubles the price the investor can pay. A longer path to exit raises the multiple needed for the same IRR. Run a small scenario table, or pair the VC method with the First Chicago method, which weights several outcomes by probability instead of betting the answer on one.
But the VC method is just made-up numbers
That's the usual complaint, and it has teeth. The exit value is a guess seven years out, the target multiple is a fund's preference, and the table above shows how far the answer moves.
But.
Every early-stage price rests on guesses. The VC method's strength is that it writes them down where everyone can argue with them. Founders can then negotiate the inputs, not just the headline. In our view that's its real value: not the number, but the conversation it forces.
Common mistakes with the venture capital method
- Using a hoped-for exit as the base case. Terminal value is better anchored to real comparable transactions than to the founder's plan.
- Forgetting dilution. Ignoring future rounds overstates what the investor can pay, in this example by about 42 percent ($30M against $21.17M).
- Mixing pre-money and post-money. The method produces a post-money figure first; see our post-money valuation guide.
- Ignoring preferences and structure. A liquidation preference changes what each share class receives at modest exits, so the headline terminal value is not what the investor gets.
- Treating the output as a price. It is a ceiling: the highest price at which this deal still clears the fund's return bar.
Learning to apply it on live deals
The formula takes ten minutes. The exit multiple and the dilution assumption are most of the argument. 1752vc's Venture Fellow program keeps that argument on real companies rather than textbook ones, across eight weeks of live virtual sessions spent on case studies, real pitch materials and due diligence on live companies. It is aimed at aspiring VCs, professionals moving into investing, and founders who want to understand how investors decide.
The bottom line
The venture capital method doesn't say what a startup is worth. It says what one investor can afford to pay on one set of assumptions. Use it as a ceiling and test the inputs.
The formula is the easy part.
The exit you believe in is the whole bet.
Key takeaways
- The venture capital method values a startup by discounting its expected exit value by the investor's target return and adjusting for dilution.
- It was formalized in a 1987 Harvard Business School note by HBS professor William Sahlman and Daniel Scherlis, which used a 50 percent discount rate in its illustration.
- VCs in the NBER survey reported a median required multiple of 5x and an average required IRR of 31 percent, with early-stage funds requiring more than the 28 to 29 percent that late-stage funds require.
- It is worth building in dilution from future rounds: in the illustrative example it cuts the maximum post-money from $30M to $21.17M.
- Running scenarios helps, because exit multiples, target returns, and timing can move the answer sharply.
Frequently asked questions
It is a way to value early-stage startups by estimating their value at exit, dividing by the investor's target return multiple, and adjusting for dilution from future rounds. The result is the maximum post-money valuation at which the investment can still hit its return target. It is a ceiling on price, not a market price.
Post-money valuation equals terminal value divided by the target multiple. To account for dilution, required ownership today equals (investment times target multiple, divided by terminal value) divided by the retention ratio, where the retention ratio multiplies (1 minus dilution) for each future round. Post-money equals the investment divided by that ownership.
Rates are high to reflect startup risk and the fact that most deals fail. The original 1987 Harvard Business School note used 50 percent as its illustration, and the NBER survey of 885 VCs found an average required IRR of 31 percent, with late-stage funds at 28 to 29 percent and early-stage funds higher. In practice, firms set their own hurdle.
It depends on estimated exit values, multiples, and dilution, any of which can be wrong by a wide margin. It handles failure risk only through a high target multiple rather than explicitly, and it ignores liquidation preferences and other deal structure that change what an investor actually receives at exit.
DCF discounts a stream of forecast cash flows, while the VC method discounts a single exit value using a high target return. The VC method suits startups with little revenue and no predictable cash flow, which is why the NBER survey found only a minority of VCs use NPV techniques at all.
Sources
- Harvard Business School Publishing: A Method for Valuing High-Risk, Long-Term Investments, The "Venture Capital Method"
- NBER: How Do Venture Capitalists Make Decisions? (Working Paper 22587, PDF)
- Harvard Law School Forum on Corporate Governance: How Do Venture Capitalists Make Decisions?
- Carta: At early stages of VC, rising round sizes and record-breaking valuations
- Carta: State of Private Markets, 2025 in Review
- Andreessen Horowitz: Performance Data and the "Babe Ruth Effect" in Venture Capital
Disclaimer: This guide is for general education only and is not legal, tax or investment advice. Laws, market data and program terms change, so it may not reflect the latest developments or fit your situation. Treat it as a starting point, not a source of truth, and talk to a qualified lawyer, accountant or financial adviser before you make decisions.
