2017-10-20 — nytimes.com
Those eye-popping valuations regularly fill articles and water-cooler conversations in Silicon Valley, all under the umbrella of "unicorn" companies -- a term for private companies that are said to be worth more than $1 billion. That moniker now applies to at least 135 businesses, making the descriptions of them as unicorns, well, less apt. (Maybe donkeys?) Early investors and employees spend countless hours calculating and recalculating how much their stake is worth.
Here is some bad news for them: Those valuations may be a bit of myth -- or perhaps wishful thinking.
In Palo Alto, Calif., just down the road from many of the biggest tech companies and the most influential venture capitalists, a professor at Stanford University has quietly been working on a project to crunch the valuation numbers behind some of these private companies.
Ilya A. Strebulaev and another professor working with him, Will Gornall of the University of British Columbia, have come to a startling conclusion: The average unicorn is worth half the headline price tag that is put out after each new valuation
That black box increasingly has relevance not just to gossips in Silicon Valley, but also to public investors. Big mutual fund companies like T. Rowe Price and BlackRock have aggressively begun investing in unicorn companies in recent years on behalf of public investors -- yes, you may own a stake in Uber and not even know it -- helping to increase the valuations even further.
And even the big public mutual funds, the researchers contend, are not properly valuing the assets. "It is inappropriate to equate post-money valuations and fair values," the professors said, explaining how, more often than not, public funds use the headline price that comes after a round of financing, and don't distinguish between various types of shares.
To cite one example from the research: In 2015, Appdynamics issued a Series F round with special terms for certain investors, including "a provision offering a 20% bonus in down I.P.O.s," meaning one that fell in price. Legg Mason, already an investor, then revalued its shares in the company at a higher price, "despite not being eligible for the 20% bonus," the professors wrote. "These examples are representative of common industry practices."
This is mostly a big deal because of the major, "main street" funds buying into these companies. As far as the VC world, everyone knows that post-money valuations are more "aspirational" than anything -- if the company is ultimately successful, you end up with a much higher "valuation" provided through IPO and the stock market anyways. And if the company is not (which is the only other possibility, and the most likely one), the "real" valuation is of course zero. So post-money valuations while a startup is growing are really more of an internal benchmarking metric than anything else; they are nothing like a cash-flow valuation of a mature company, or a share price in the stock market.
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