VC Cliche of the Week
Several years ago, we were offered the opportunity to sell our interest in Inteliseek, which was merged yesterday into the new Nielsen Buzzmetrics. We declined the opportunity because although the offer for our stock was fair value given where the Company was at the time, we felt that our stock had option value.
Option value is a cliche I hear a lot in the venture capital business and it is fundamental to what we do, particularly the early stage venture business.
I believe that regardless of the "valuation" placed on the Company in most first round investments, what you are really paying for is option value.
Option value means the potential for a gain. If you own 20% of a company, you own 20% of the current value plus 20% of the potential upside. It’s the latter that I am calling option value.
I heard recently about a book or an article that made the case that options are bad. That people actually prefer less choice not more choice. That may be true in real life, but it is certainly not true in money and finance.
Options, particularly long life options, which is what early stage stock really is, are very valuable. It’s hard to value these instruments with traditional option pricing mechanisms but we know that if you hold onto them and good things happen with the portfolio company, you are going to get rewarded.
So the next time you buy or sell early stage stock, think less about the current value of what you are buying, because there honestly isn’t much value in an early stage company, and think more about the potential value creation, the odds of success, and the time frame it would take to get there, and value what you are buying or selling as an option. You may be surprised at the results of that analysis.