What is the difference between VC and PE in equity investment?

There are many methods of value assessment, which can be categorized into many types according to different classification standards. Theoretically, value assessment methods are mainly divided into two categories, one is the absolute value assessment method, mainly using the discount method, which is more complex, such as discounted cash flow (DCF), option pricing methods, etc., and is the mainstream method used in mature markets. The other category is the relative value assessment method, which mainly adopts the multiplier method and is simpler, such as P/E, P/B, P/S, PEG and EV/EBITDA value assessment method, which is more popular and practical in emerging markets.

"VC" means "Venture Capital". It is also often translated as "Venture Capital" in China. "PE" is "Private Equity", "Private Equity", they are both closely linked and different from each other a pair of concepts. VC and PE are both investing in the equity of unlisted enterprises, and their specific business fields are increasingly intersecting; however, in a strict sense, they are different in terms of investment object, investment stage, investment industry, and investment scale, etc. VC and PE usually choose one or two valuation methods, supplemented by other methods, to calculate a value that is acceptable to both investors and financiers. That is, to take the primary and secondary, complementary valuation methods.

One, VC, PE valuation of investment projects

VC, PE investment projects often use valuation methods: P / E, P / B, P / S, PEG, DCF and other value assessment methods.

(A) P/E method (price-earnings ratio method)

Currently in the domestic equity investment market, the P/E method is a relatively common valuation method. Usually what we call the price-earnings ratio of a listed company

There are two kinds of P/E: Historical P/E (Trailing P/E), the current market capitalization/company's profit in the last financial year (or the profit in the first 12 months); Forecast P/E (Forward P/E), the current market capitalization/company's profit in the current financial year (or the profit in the next 12 months). Investors are investing in the future of a company, is the company's future operating ability to give the current price, so the price-earnings method of assessing the value of the target company is calculated as follows:

Company value = Forecast P/E x company's profit for the next 12 months.

As can be seen from the formula, the price-earnings ratio method requires two basic tasks, namely, the price-earnings ratio and the determination of the target company's earnings. The price-earnings ratio can be chosen from the price-earnings ratio of the target company at the time of the merger and acquisition, the price-earnings ratio of companies with comparable target companies or the average price-earnings ratio of the industry in which the target company is located. The level of the P/E ratio depends mainly on the expected growth rate of the enterprise, a growth enterprise is valued much higher than a business with only average level of future earnings, it will use a higher P/E ratio; and for a risky business, the P/E ratio is lower because investors require a large return as well.

Advantages: the data for calculating the P/E ratio is easy to obtain and simple to compute; the P/E ratio relates price to earnings and visualizes the relationship between inputs and outputs; the P/E ratio is highly comprehensive as it covers the effects of the risk compensation ratio, growth rate, and dividend payout ratio.

Disadvantage: If earnings are negative, the P/E ratio loses its meaning. The P/E ratio is affected by the fundamentals of the company itself, but also by the degree of prosperity of the economy as a whole. P/E ratios rise when the entire economy is booming and fall when the entire economy is in recession. If the target firm's beta is 1, the appraised value correctly reflects expectations for the future. If the firm's beta is significantly greater than 1, the appraised value is inflated during economic booms and reduced during recessions. If the β value is significantly less than 1, the appraised value is understated in a boom and overstated in a recession. If it is a cyclical business, the enterprise value may be skewed.

(ii) P/B Method (Price-to-Book Ratio Method)

P/B ratio is the ratio of market value to net assets, or the ratio of share price per share to net assets per share. The main steps in valuing a P/E ratio are much the same as for a P/E ratio, except that the main variable changes from earnings per share to net assets per share.

Advantages: companies with negative net income cannot be valued using the P/E ratio, whereas the P/E ratio is rarely negative and can be used for most companies; data on net book value are easy to obtain and easy to understand; net book value is more stable than net income and is not manipulated as often as profits.

Disadvantages: book value is affected by the choice of accounting policy, if each enterprise implements different accounting standards or accounting policies, the P/NAV will lose comparability; service and high-tech enterprises with very few fixed assets, the relationship between net assets and enterprise value is not very large, and the comparison of P/NAV has little practical significance.

(C) P/S method (market-to-sales ratio method)

Market-to-sales ratio is the ratio of market value to sales revenue. In cases of cost control, similar tax burden, etc., the value of a company may depend primarily on its sales capacity. The main process of using P/S ratio as a valuation is also similar to other relative methods of valuation, where the main variable becomes sales revenue per share.

Advantages: sales revenue is the most stable and less volatile; and sales revenue is not affected by the company's depreciation, inventory, and non-recurring income and expenses, unlike profits, which are easy to manipulate; revenues will not be negative or meaningless, and can be used even if net income is negative. Therefore, the price-to-sales valuation method can be a good complement to the price-to-earnings valuation method.

Disadvantages: it does not reflect the company's ability to control costs, and it does not reflect the differences in the cost structure of different companies; high growth in sales revenue does not necessarily mean growth in earnings and cash flow.

(D) PEG method

It is developed on the basis of PE valuation, which makes up for the lack of PE method to estimate the dynamic growth of the enterprise, and the formula is: PEG = P/E/enterprise annual earnings growth rate.

Advantages: the P/E ratio and the growth of the company's performance will be viewed in contrast, where the key is to make accurate expectations of the company's performance.

(E) DCF Method

DCF (Discounted Cash Flow), which is the discounted cash flow method, is usually the preferred method of enterprise value assessment. The cornerstone of this method is the "present value principle," which states that the value of any asset is equal to the sum of the present values of all its expected future cash flows.

The steps of the DCF method are:

(1) Determine the number of years of future earnings, T;

(2) Forecast the cash flows over the next T years;

(3) Determine the expected rate of return (the discount rate);

(4) Discount the cash flows using the discount rate and then sum them up.

The formula is: the current value of the enterprise = ∑ [FCFEt/(Hr)t] + VT/(Hr)T

Wherein, FCFEt: the expected free cash flow in the tth period; r: the discount rate (according to the specific circumstances of the corresponding cost of capital K or the weighted average cost of capital WACC); t: years of earnings (the length of time that the enterprise can survive or the enterprise can be foreseen future period); V: discounted cash flow; V: discounted cash flow (the discount rate), and then summed. (the length of time that the enterprise can survive or the future period that the enterprise can be foreseen); VT: the terminal value of the enterprise in year T; T: the forecast period from 1 to T.

Depending on the different needs, the DCF method can choose different lengths of the forecast period, for example, 8 years, 10 years or even a longer period. In the practice of valuation, VCs and PEs pay more attention to the forecast period of 3 to 5 years, because in such a length of time, the business results of the enterprise are considered to be predictable.

The DCF method is relatively perfect in theory. Under a given situation, if the current cash flow of the valued enterprise is positive, and the time of occurrence of the future cash flow can be estimated relatively reliably, and at the same time, the appropriate discount rate can be determined based on the risk characteristics of the cash flow, the discounted cash flow method is suitable. But the reality is often not the case, the actual conditions and the model assumptions of the preconditions are often far away, then the use of the DCF method will become very difficult, the method is more suitable for the company can continue to bring positive cash flow to investors.

Two, VC, PE investment projects for different industries in the valuation method selection

In terms of different industries, the traditional industry enterprises, VC, PE priority DCF, P / E; high-tech enterprises, VC, PE is generally preferred to P / E. In terms of the different stages of investment and different financial status, if the investee company is in the early and mid-stage development and has not yet achieved profitability, then VC, PE is generally preferred to P / E. In terms of different investment stages and different financial status, if the investee company in early and middle stage development and

If the investee company has already realized profit, P/E, DCF and PEG will be used more often; if the investee company has already been in the middle and late stage of development, the company has already realized profit, and the development of all aspects has been more mature, the IPO is also expected to be stronger, VC, PE is more common to use P/E and DCF. P/E and DCF are used.

Valuation of unlisted companies, especially startups, is a unique and challenging task, and the process and methodology

is usually a combination of science and flexibility. It is an economic truth that prices always move up and down around the true value of a business. For both entrepreneurs and investors, it is important to discuss the valuation of a business with the mindset of *** with creating future value, and *** a winning posture, which is the beginning of a new round of strong business development. On the contrary, poorly handled price and value will lay the groundwork for all kinds of infighting crises in the future. So, when it comes to enterprise valuation, you need to grasp a degree.