New research indicates ‘Unicorns’ are overvalued
gsb.stanford.edu
gsb.stanford.edu
These authors have developed a system to tease out the optionality using standard financial methods (using methods like Black-Scholes, for example), which can give us all a better understanding of the true worth of these companies. Far overdue in my opinion.
I'm not familiar with tern "optionality" can you say what that is and how it provides downside risk protection to investors? Thanks.
With preferred shares, investors have the option of taking either some percent of the company, or of instead taking a flat payment equal to their original investment (or more). For example, if a venture investor invested $100 into your lemonade stand, they could choose either to get the first $100 when you sold the stand, or to get 20% of the sale price. As long as you sold it under $500, they would take their $100 back, but if you sold it over $500 they would take 20%. If you sold it under $100, they would get all of it. That's the downside protection, since you'd be left with less than 80% of the proceeds even though nominally you own 80% of the business.
A related question I have then is would RSUs be considered as providing downside risk(but no upside) for employees then as the value is independent of the companies actual performance?
As an aside, this is why I think that any effort of a prospective employee to divine the value of a stock option package is likely in vain. Without a detailed accounting of the ins and outs of the preferred stock that is senior to your common shares, it is nigh impossible to tell how much the common shares (and options thereon) are worth.
People don't like to have that conversation because they think it's inappropriate. However, it's more inappropriate for a founder to tell you that you're getting equity in lieu of compensation and explain nothing about the value of that equity and potential future value of that equity based on the current state and future state assumptions.
I mean, I was the first employee at a startup, involved with fund raising, and then founder at a startup, and even I would have a hard time with that.
Not to mention that even if you have a very solid understanding of what things are like when you get hired, it can all change dramatically in subsequent fundraising.
This is just one of many instances where the employee/employer relationship is heavily biased against the employee. And unless clear disclosure requirements understandable by the average worker are put in place, it'll stay that way. As an employee, your options are inscrutable lottery tickets which value can be redefined in many ways at many points in time, and there's not much you can do against that.
Totally - I've been thinking about actually putting on a "equity master class for engineers looking to join startups" type seminar in the bay area if people are interested.
https://goo.gl/forms/j70V7ew5Dds7AoOt1
If there's enough interest I'll put something on.
PS - By way of background, I work in tech M&A and regularly see cap tables, equity packages, salaries etc. both in and out of SV.
Yes, thanks for spotting the typo. Fixed.
If founders and investors really want to align their goals with employees, then start handing out rev share, otherwise, the employee is just deluding themselves.
The only thing I would value is participation in a trust designed to make it as difficult as possible for the founder to receive cash from their ownership stake without paying out to all minor participants. "If he's worth $1B, I'm worth $1M" is something I can value.
You've heard of this company.
You also trade off any ordinary protections as a consumer.
I really enjoyed the TL;DR stock option visualization earlier but for unicorns it would be a really interesting exercise to walk through various 'liquidity events' and their value and see the various percentages that went to which investors.
Where is the disconnect...?
However, let's look at another example. Take Nutanix (Series E valuation at 2 B, pre-IPO at 2.1 B). This model values it at 0.8 B on their table, almost a third of the IPO price.
There is no explanation forthcoming in this article as to why that's the case. This makes it seem like the Square example was cherry-picked.
I picked NTNX at random, so I don't know if it's the one exception. I'm not going to exhaustively check every result, however. I expect them to do that for me and not sell me a story without pointing out the terrible exceptions.
However.
How many startups never IPO? 99%? 99.9%? In acquisition or liquidation scenarios, those common shares are often worth a lot less than preferred. And because these scenarios make up a large proportion of the probability distribution, it means the expected value of common shares is a lot lower.
Even unicorns that are far more likely to IPO can raise bridge rounds that cause major dilution for the common shares, rendering previous market capitalization numbers useless.
There's more money than there are good deals in Silicon Valley, so later stage investors are forced to offer more money for less equity in order to beat other term sheets. This ends up looking like sky-high valuations, since investors that offer fair-market-valuations are unlikely to get picked. Founders naturally gravitate towards minimizing dilution.
More complex packaging is part of it (think confusopoly of mobile plans applied to investing) and I think the paper has useful advice for "non preferential" investors, but it's not the whole story.
Is that true? VCs aren't acting the way they would if they really believed it. If they did, they would refuse funds from potential LPs, since they really can't find professionally responsible places to invest it. But that's not what they do. Alternately, they might take the LPs' money, warn them carefully that they could be investing in some real longshots, and then be willing to invest on fairly generous terms in any number of startups that look to be competently run and pursuing plausible opportunities. But that's not what they do, either.
Something doesn't add up.
There are many funds structured in a way where it's better for the fund (not necessarily for the investor) to invest 2x in questionable companies, than just 1x in great companies, lest they lose fees on the remainder.
How much is something really worth. Well how much is the next person willing to pay, that's really what this is all about. I've been down the road of VCs, exits etc... before and to be honest most of it is just fluff people make up, loop holes in the way things are valued, forget basic business and accounting they literally are making this up as they go.
Most VCs I feel have a detrimental effect on startups, the only thing a lot of them provide is money, which isn't always what a startup needs. It doesn't matter to the VCs that they are mostly wrong, they just have to be right once.
The question we need to ask here is what happens when it all crumbles down, due to the fact that all this is going on. How valuable something is ultimately depends on how many lives it improves. Whether something is valuable or not is measured by the amount of pain inflicted on society if the startup didn't exist, and ultimately if something is not needed, it wont survive anyway. The market is cruel like that, and having VC money shields entrepreneurs away from that crucial factor. All this fluffed up valuation has nothing to do with the survival of a business anyway.
The problem there is that anyone riding right up until the very end has a pretty substantial return advantage over the folks who stepped off early and turtled up.
Which gives a perverse incentive to stay all in, which gives everyone an incentive to keep the wheel spinning for as long as possible, which is probably why crashes only tend to happen with an external spark.
The ultimate value is instead rather circular: how much something is worth, is how much you can make people think it's worth. As we head towards general AI, we can generalize this: how valuable something is depends on how much people and AIs/systems think it's worth. Whether it improves anything at all, is very much optional.
So if this article is to be trusted it is overvalued by 4.4 B $. that is another square.
https://www.amazon.com/Venture-Deals-Smarter-Lawyer-Capitali...
The subtitle is tongue in cheek but also gives you a sense of how much you can learn and how rare company you are in once you understand the details.
AIUI, the common share FMV they list should be comparable to the 409A common share valuations you may have gotten. Roughly speaking, assuming the funding round in the table is close in time to the 409A valuation.
Nevertheless, it's not that much: 50-100%. that's hardly a dot-com bubble bust.
10 apples are worth $100. 90 oranges are not therefore worth $900.
We have drifted far from the vision of people building up computing.
unicorn valuation is the same mechanism.
do it so obviously wrong that you only draw dumb people who think they are the only ones smart enough to see the valuation is off so they buy thinking they can profit from their clever and unique insight. and the scam is complete.