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Squaring Venture Capital Valuations with Reality
- thefalcon 9y agoI'm actually surprised that it's as low as 50% of unicorns playing these valuation games.
- zilchers 9y agoI wouldn't even call these complex mechanics - TFA basically says more favorable terms in later rounds (liquidations preferences, etc) mean that the high share price in those rounds shouldn't be used as the price for all outstanding shares. This is a great point that I hadn't really thought about before, but I would also expect people smarter than me to bake into their valuations.
- tonmoy 9y agoAnd the other other half are undervalued then.
- vm 9y agoIt's not a zero sum game. Company valuations are independent.
- deleted 9y ago[deleted]
- fullshark 9y agoBut can't you be only either undervalued or overvalued? There is a knife's edge at properly valued but seems like almost all companies are one or the other.
- twinkletwinkle 9y agoThe other half could be overvalued for other reasons.
- freshhawk 9y agoNope, because none of them are calculating valuations using their lowest priced shares are they?
- Powerofmene 9y agoThat would be true if 1 + 1 = 2 but stock pricing changes by the minute/day/good news/scandal/hiring/firing, etc. Some of their valuations may have been on the money for the minute that it was determined but so many factors come into play even a huge over-valuation could even out next week based on a great quarterly report or a contract signed or if the right CEO is hired on an otherwise adrift ship.
- tedunangst 9y agoYou could at least read the paper abstract instead of relying on the made up HN title... The actual claim is "almost one half (53 out of 116) lose their unicorn status when their valuation is recalculated". So, yes, if half lose unicorn status, then the other half do not lose their unicorn status. Is that really such a keen insight?
- jhanschoo 9y agoIf we assume a simplistic log-normal distribution over the valuations of startups, and overvaluation is exactly half, this would mean that as a whole, startups are overvalued (median<mean)
- luu 9y ago> And the other other half are undervalued then. You must be responding to the current HN title and not anything from the actual paper? This comment doesn't make any sense otherwise. The paper literally has an entire section titled "All unicorns are overvalued" (section 4.2) and figure 3 shows the distribution of overvaluations given their methodology.
- justboxing 9y agoRelated: Stewart Butterfield on his Unicorn status: "It's arbitrary as f*ck. There's no logic to what you get valued at" => https://pando.com/2015/02/10/stewart-butterfield-on-his-unicorn-status-its-arbitrary-as-fuck-theres-no-logic-to-what-you-get-valued-at/ https://pando.com/2015/02/10/stewart-butterfield-on-his-unic...
- sjg007 9y agoI would worry less about their value and figure out if they can make money or if after the IPO people believe it.
- stanleydrew 9y agoThe rank and file employees of VC-backed companies often receive much of their pay as stock options. The naiive approach, likely used by many of employees, would dramatically overvalue their wealth. For example, the stock options Square issued around the time of its 2014 funding round had a strike price of $9.11.4 The naiive approach would take Square’s 2014 financing round at $15.46 per share and view these options as $6 in the money. Our approach shows the “fair” common share price was actually closer to $5.62, so these options were significantly out of the money. Seems like this paper could provide a new 409a-compliant valuation method for common stock which might help to price employee options a bit better for these later-stage companies.
- pge 9y agoExisting 409A valuations already take all of that into account. When an employee is issued options, the one thing he can be reasonably sure of is that they are not in the money. Options have to be issued at or above the FMV for common stock, or it is taxable compensation to the employee. Note the "at or above" language. An employee's option has to be out of the money the day it is issued, but that could be by .01 or many dollars. The Board almost always has a valuation report done by a third party that values each class of stock separately, taking into account the various preferences and so forth. All of that is taken into account when assigning a value to the common options being issued.
- jogjayr 9y agoCorrect me if I'm wrong but the relevant 409A valuation is the most recent one done when you exercise your options and taxes on them become due. I think that's the situation GP was referring to, that this approach might help fix. Unless you're saying that when Square's valuation suggested a share price of ~$15, a 409A done at the same time would have returned a value closer to the ~$5 that the paper suggests is more reflective of the average employee's situation.
- stanleydrew 9y agoYou're not wrong, but this isn't just about taxes. In the case of Square, apparently they got a 409a valuation done that set a FMV for common of $9.11 and then issued options with that strike price as is standard practice. Anybody who exercised immediately at $9.11 probably wasn't subject to any tax liability (assuming appropriate 83b election). Employees exercising at that price may have fooled themselves into thinking they were already $6/share in profit-land, which would be incorrect and is the point of the article. But the bigger problem to me is that employees were fooled into paying $9.11 for something that was actually worth far less.
- zitterbewegung 9y agoReminds me of @dhh [1] except with causation. The example he used was Facebook but I think the oncoming adtech implosion might prove him right . [1] https://signalvnoise.com/posts/2585-facebook-is-not-worth-33000000000 https://signalvnoise.com/posts/2585-facebook-is-not-worth-33...
- markeroon 9y agoGiven that Facebook is now worth $500B, this seems like a weird article to post.
- ridruejo 9y agoSome interesting data points and explanation of some of those terms https://www.fenwick.com/publications/pages/the-terms-behind-the-unicorn-valuations.aspx https://www.fenwick.com/publications/pages/the-terms-behind-... https://www.fenwick.com/publications/pages/unicorn-survey-as-of-december-31-2016.aspx https://www.fenwick.com/publications/pages/unicorn-survey-as...
- indescions_2017 9y agoOf equal interest is author's other paper entitled "How Do Venture Capitalist's Make Decisions?" And after 900+ interviews it's neither jockey nor horse nor any other correlation, but spray and pray all around. Am currently negotiating a small ($10k) angel investment in an ecommerce startup in Indonesia. All "go" signals are there: ambitious team, growing market, outside foreign investment, etc. But as far as calculating a probability for any IRR? 50% it goes to zero, 50% chance 10x or better return, is as good as any model for the risks faced at early stage. So what was the data point that finally tipped the scale for me to pull the trigger? The fact that in Jakarta you can hire a fresh, world-class engineering graduate for $500 a month to come work for you!
- cshenton 9y ago50% seems like pretty optimistic odds for an angel investment.
- ingenuous2 9y agoin general, but with just a $10k angel, the odds of becoming a $100k company are pretty decent.
- dieterrams 9y agoA $100k company could only be a 10x return for a $10k investment if that investment was for 100% of the company.
- linkregister 9y ago> The fact that in Jakarta you can hire a fresh, world-class engineering graduate for $500 a month to come work for you! That's nuts, considering English teachers make about $1000 per month. Then again, there's such a dearth of opportunity for talent in Indonesia that I don't doubt your figure at all. I can't count how many engineering graduates from Bandung I met who are low-skilled office or vocational careers. I noticed you didn't mention government connections to the startup. At some point they need to either pay unsustainable bribes or call a highly-placed friend or relative to stay in business, or so I have been led to believe. Jakarta is an amazing city. I would love to use a product developed in Indonesia. I hope to see that startup's Show HN sometime soon.
- smegel 9y agoDon't companies get bought out on the basis of how many users they have not some funny-number "valuation"?
- dkural 9y agoIt's always the press claiming that valuation for the whole is equal to the latest preferred share price. Companies merely say, we issued a new class of shares and raised $ at price X. Company total value = sum of each class of stock#outstandingprice$
- cma 9y agoI was always confused by this response: > pg: "Yes, investors with preferred stock usually get their money back first. Sometimes they get a multiple, but that's considered overreaching nowadays and the more promising startups never have to agree to that. I suppose that is implicitly a target valuation in a sense. But no one views it as a target, because it only matters if things go badly." https://news.ycombinator.com/item?id=6896833 https://news.ycombinator.com/item?id=6896833 Of course it only matters if things go badly..
- lnanek2 9y agoThat's how I feel about it as an employee. If the startup doesn't do well my equity is worthless anyway, so I don't really care if it is a clean round or lots of tricks to get the valuation/share price up like that by promising investors more preference when it doesn't do well.
- stanleydrew 9y agoThis is pretty short-sighted though. The definition of "doing well" is relative to the last round's valuation, regardless of business fundamentals. So if your company is actually worth $100M, but you raise $150M at a $1B valuation with a 1x preference, you would get nothing if the company sells for $150M later that year. That would have been a 50% return on the actual true company valuation, had you actually raised at that. This is an extreme example but hopefully you get what I'm saying.
- robocat 9y agoIn your example the company has lost $100M, not gained 50%... E.g. company has $100M cash and no other assets, receives $150M cash, then later sells company for $150M.
- stanleydrew 9y agoYes, that's my point. The company "didn't do well" by the standards of the previous round they raised. But had they raised a round that valued them more appropriately, they may have "done well".
- nurettin 9y agoReminds me of the over-inflated house prices of Istanbul. (300% increase over the course of 5 years) Perhaps prices aren't as dependent on "complex stock mechanics" as it is dependent on supply/demand. Demand being made up of increasing levels of wealth (or credit) and supply being made up of pure greed.
- vintageseltzer 9y agoIsn't the massive devaluation of the lira over that time period the main factor?
- nurettin 9y agoAverage devaluation is 10%/year in other sectors. Doesn't look like a main factor.
- std_throwaway 9y agoIt's not overvalued if people are still paying the price. Only the last fool in a long line will get hurt.
- swarup182 9y agoyeah, the last group of fools.
- prostoalex 9y agoThe last fool is likely to be some guy who eats and breathes finance. The last fool who did not negotiate liquidation preferences, ratchet provisions and a board seat will get hurt, though.
- led76 9y agoHow is the paper getting its data? Maybe I didn't read carefully enough, but don't they need to know the liquidation preferences of the rounds?