A defining feature of startup financing is its staged structure: in each funding round, venture capital (VC) investors have the option to continue financing or to abandon a startup. By exercising the financing option, VC investors retain the option to eventually take the startup public, typically on the Nasdaq. We model startups as compound options on underlying firms that, upon successful exit, list on the Nasdaq. Our startup valuation model closely matches the IPO time series of startups, delivers closed-form expressions for startup betas over the lifecycle of these ventures, and yields a key insight: a portfolio of startups resembles a leveraged position in the Nasdaq. This replication strategy, implementable at low cost, tracks the performance of VC fund vintages with striking accuracy. Over the past two decades, VC has significantly underperformed this benchmark.
Sebastian Hillenbrand, Harvard Business School
Erik Stafford, Harvard Business School