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Real Options
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Venture Capital and Startups
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Dear Readers –

I tried. Three different research assistants were hired to double check the calculations in Value Sweep. Unfortunately errors have crept through. My apologies for any inconvenience this may have caused you.

The following are corrections to errors I am currently aware of. If you believe you have caught any others (I hope not!), please write to martha@valuesweep.com.

The downloadable spreadsheet on the website contains these corrections (marked in burnt orange font) and thus will not agree with the printed book pages of your book copy. The book will be updated at the next printing.

Many thanks to the alert readers who caught these errors.

Regards,

Martha Amram

Chapter 7
Tables 7-1 and 7-2. The error in these tables is the use of the wrong S in the S/X ratio used to calculate the option value factor. The correct input is S (the value of the payoff at the start of the preceding stage). The incorrect input leads to incorrect results throughout the table. See the correction made on the downloadable spreadsheet The changes make the legends under “Write the Story” incorrect and an alternate version of the examples, with corrected legends, is also provided.

Chapter 8
Table 8-3. The error in this table is the use of the wrong S in the S/X ratio, used to calculate the option value factor. The correct input is S (the value of the success payoff at the start of the preceding stage). The incorrect input leads to incorrect results throughout the table. See the correction made on the downloadable spreadsheet.

One reader has questioned the use of a constant discount rate throughout this table, wondering if the discount rate used on S should increase as the volatility increases. My response is that a private company with a high amount of private risk is likely to have the same beta as a mature company in that sector. The high amount of private risk is eliminated in a diversified portfolio. (I assume the CAPM is used to set the discount rate and that there is no debt.) It is probably not a bad approximation to use a constant discount rate.

Table 8-4. This table also uses the wrong input for S and has been corrected. The results are that in a cold market, venture valuations fall relatively more for early-stage investments. The reason is that while early-stage investments are an option on the IPO value, the option increase is smaller than the PRD and the net effect is a relative decline in value. You can see this by calculating the cumulative effect of the PRD on the value of a startup. Ignoring the option component, the startup value from the PRD alone is about 13% of the IPO value, or under $10. It is the option value that raises the result from under $10 to the $13 shown in the calculations.

Similarly, in the hot market the option value increases the value of the startup company relative to the IPO value, but the PRD discounts the value. For the hot market values shown in Table 8-4, the magnitude of the PRD outweigh the option component so the net result is that the early stage companies move up less than does the IPO value. You can see this by momentarily setting the PRD in the hot market to zero – the early-stage investments now show their option like feature.

Chapter 13
Table 13-1. The terminal value should reference the free cash flow in 2003, not the cumulative present value of free cash flow. This changes the value of the firm and the portion explained by the DCF model.

Also, P&G reports operating profits net of depreciation, and thus depreciation is added back in to obtain free cash flow. Depreciation was inadvertently omitted in the first printing.

Table 13-2. There is a link to results in Table 13-1 on the second line. The results below this line are necessarily changed.

Appendix
Table A-3. The notes should read t=2, not t=3. The table is correct on this matter.

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