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Honest question: is the unicorn valuation just a tool for VCs to inflate the value of their stock in the second market? Here's a scenario that happened recentl

Honest question: is the unicorn valuation just a tool for VCs to inflate the value of their stock in the second market? Here's a scenario that happened recently. Investors X and Y invested a $30 million Series A in UnicornCompany. Lets just say its a $200m valuation. Those same exact investors invested a $50m Series C at a $2 billion unicorn valuation (no new investors). Doesn't that mean their initial investment is now worth 10x in the open market? Thus making their return at least $300m on $80m invested?

bb88 8y ago
Yes, but they actually have to sell their shares for $x billion if they want to see any actual profit. Future investors are likely to be skeptical if the current and projected income doesn't match the valuation.
tim333 8y ago
It's more complicated than that. What a company actually trades for in the open market is down to investors opinions and may be different from 'what the company is worth', which is also a little in the eye of the beholder. However after the C the VCs may be able to report a 10x return to their investors.
mikekchar 8y ago
No. You are conflating "valuation" with "value". Let me give you an example. My company has 10 shares total and I manage to get you to buy one of them for $100. The logical conclusion is that the shares are worth $100 each and the company is worth $1000. You hold 1 share, and I hold 9 shares. I also have the $100 you gave me. So one can say that you bought 10% of the company at a $1000 valuation. But let's say I don't do anything at all with the money you gave me and I had no other money to begin with. What that means is that you have 1 share and I have 9 shares and $100. If we liquidated the company now, you would get $10 back and I would keep $90. The company has a value of $100. Now let's say that somebody is really interested in buying shares. I give you the OK to sell your share and somebody offers to buy it for $10,000. You sell your share for $10,000 (10% of the company). The logical conclusion is that the other 9 shares are worth $90,000 and the whole company has a valuation of $100,000. But I still only have $100 in the bank :-) Now, let's say that encouraged by the huge profit you made, you buy 4 shares at $20,000 each from me. The valuation of the company is logically $200K because there are 10 shares and the last time someone bought some it was for $20K each. You own 40% of the company. I own %50 of the company and they person who bought the original share from you owns %10 of the company. The company has $80,100 in the bank. You try to sell your 4 shares now, but nobody wants to buy. The shares have a nominal value of $8,010 each ($80,100 / 10 shares), but nobody feels like buying. Your shares are worth 0 because I control the company and don't want to liquidate. Basically, I conned you into giving me $80,100 :-) Shares are worth what other people are willing to pay for them. Whether or not someone will be willing to buy your shares back for the current "valuation" of the company depends a lot on the circumstances. Whether you are even able to sell your shares depends on agreements you made, etc, etc. You can easily have a company with a $1 billion valuation whose stock is worth less than toilet paper in reality. Companies that are pre-IPO are really ripe for the hype machine. You generally can't trade their stock except at a "liquidation event". You can invest in them, and their valuation might climb, but you can actually realise any of that profit. If they pull a Theranos on you, then you lose all of that money. Once a company has IPOed, the stock is traded freely on the stock market. Since it is liquid, you are more likely to be able to sell your stock close to its current valuation. Keep in mind that this is still not the same as value -- stocks usually trade a prices of multiples of the current value (because people believe the companies will increase in value over time). Edit: I have trouble multiplying by 4... :-P
bksenior 8y ago
Outside of the obvious increase in value, it tends to be lost that VCs are money managers. Mark-ups serve as marketing for the next fund which they get a % of an annual basis. The time horizon to see any company turn to cash is so long that their major day-to-day level is to market a strong rising portfolio to new LPs for more money to manage.
PeterisP 8y ago
Artificially inflating a valuation is not in VC interest - after all, an inflated valuation means that they're getting less % shares of the company for the same money. VCs generally don't get any meaningful impact from intermediate numbers, they get their numbers - both regarding investor returns and their carry fees - only on exits. So the share they get for that money has a direct impact on how much money the VC personally takes home after the exit. Any before-exit valuations have only a PR effect for them (which may be a factor if they want to raise a new round anyway right now, and are failing at that - but if they can raise a new round, then this PR won't bring them any extra profit), and any useful effect on the secondary market is too far in future; if there's an investment round happening now, then any potential buyers would be in that investment now; at this point the participating VCs are participating because they want to increase (or at least maintain) their share, not divest it - and if they want to divest after a year or so, the valuation PR effect will have faded. The benefits of such a valuation to the startup, on the other hand, are much more clear.
- kcorbitt 8y ago
  > VCs generally don't get any meaningful impact from intermediate numbers, they get their numbers - both regarding investor returns and their carry fees - only on exits. The incentives can change if you look one level deeper. VCs often need to start raising a new fund before all the positions in their existing fund are fully liquid. By artificially inflating the valuations of their old fund, they can demonstrate high performance to LPs, which may help them raise more capital for the new fund.
  - klank 8y ago
    > By artificially inflating the valuations of their old fund, they can demonstrate high performance to LPs, which may help them raise more capital for the new fund. Where is the line between that and a ponzi scheme? How legal the artificial inflation is? Or is it that the valuation that's being artificially inflated isn't a return per se, but rather highly correlated with returns?
  - PeterisP 8y ago
    It's true, however, if we look at what impacts the money that VCs actually get themselves, "help them raise more capital for the new fund" only matters if they're having trouble with raising that round (as I mention in the post above). In normal circumstances, where they can raise the amount the next round should have (i.e. one that they can invest with a good return) this isn't helpful. More capital for the fund doesn't necessarily benefit them - they need enough pledged money for the fund, but if they get the ability to pay twice as much for the same startups, that only decreases their take-home carry after the fact; if they have so much capital that they have to invest it in worse startups just to invest it in the expected timeline - that means worse results and less profit for them; if they raise extra capital for the fund that's sitting unused, then it decreases their overall profitability ratios and again means less profit for the VCs personally. However, if it's difficult for them to get enough investors for the next round (e.g. during an economic downturn) then yes, in such particular cases the PR advantage might be useful. But it's not in most cases, and not now, and the impact isn't that much - the organizations who invest in VC funds (i.e. the limited partners) aren't stupid as well, they can afford to do a lot of due diligence and all the data for the valuations and discussions and doubts about the valuations is available for them. You could just as well argue that if they inflate valuations, then the community of limited partners might think that they're not prudent with their money and avoid investing in their next fund. PR smoke and mirrors works well on the general public, but less well (though not at zero effect) on the large investing institutions.

bb88 8y ago

Yes, but they actually have to sell their shares for $x billion if they want to see any actual profit. Future investors are likely to be skeptical if the current and projected income doesn't match the valuation.

tim333 8y ago

It's more complicated than that. What a company actually trades for in the open market is down to investors opinions and may be different from 'what the company is worth', which is also a little in the eye of the beholder. However after the C the VCs may be able to report a 10x return to their investors.

mikekchar 8y ago

No. You are conflating "valuation" with "value". Let me give you an example. My company has 10 shares total and I manage to get you to buy one of them for $100. The logical conclusion is that the shares are worth $100 each and the company is worth $1000. You hold 1 share, and I hold 9 shares. I also have the $100 you gave me. So one can say that you bought 10% of the company at a $1000 valuation. But let's say I don't do anything at all with the money you gave me and I had no other money to begin with. What that means is that you have 1 share and I have 9 shares and $100. If we liquidated the company now, you would get $10 back and I would keep $90. The company has a value of $100. Now let's say that somebody is really interested in buying shares. I give you the OK to sell your share and somebody offers to buy it for $10,000. You sell your share for $10,000 (10% of the company). The logical conclusion is that the other 9 shares are worth $90,000 and the whole company has a valuation of $100,000. But I still only have $100 in the bank :-) Now, let's say that encouraged by the huge profit you made, you buy 4 shares at $20,000 each from me. The valuation of the company is logically $200K because there are 10 shares and the last time someone bought some it was for $20K each. You own 40% of the company. I own %50 of the company and they person who bought the original share from you owns %10 of the company. The company has $80,100 in the bank. You try to sell your 4 shares now, but nobody wants to buy. The shares have a nominal value of $8,010 each ($80,100 / 10 shares), but nobody feels like buying. Your shares are worth 0 because I control the company and don't want to liquidate. Basically, I conned you into giving me $80,100 :-) Shares are worth what other people are willing to pay for them. Whether or not someone will be willing to buy your shares back for the current "valuation" of the company depends a lot on the circumstances. Whether you are even able to sell your shares depends on agreements you made, etc, etc. You can easily have a company with a $1 billion valuation whose stock is worth less than toilet paper in reality. Companies that are pre-IPO are really ripe for the hype machine. You generally can't trade their stock except at a "liquidation event". You can invest in them, and their valuation might climb, but you can actually realise any of that profit. If they pull a Theranos on you, then you lose all of that money. Once a company has IPOed, the stock is traded freely on the stock market. Since it is liquid, you are more likely to be able to sell your stock close to its current valuation. Keep in mind that this is still not the same as value -- stocks usually trade a prices of multiples of the current value (because people believe the companies will increase in value over time). Edit: I have trouble multiplying by 4... :-P

bksenior 8y ago

Outside of the obvious increase in value, it tends to be lost that VCs are money managers. Mark-ups serve as marketing for the next fund which they get a % of an annual basis. The time horizon to see any company turn to cash is so long that their major day-to-day level is to market a strong rising portfolio to new LPs for more money to manage.

PeterisP 8y ago

Artificially inflating a valuation is not in VC interest - after all, an inflated valuation means that they're getting less % shares of the company for the same money. VCs generally don't get any meaningful impact from intermediate numbers, they get their numbers - both regarding investor returns and their carry fees - only on exits. So the share they get for that money has a direct impact on how much money the VC personally takes home after the exit. Any before-exit valuations have only a PR effect for them (which may be a factor if they want to raise a new round anyway right now, and are failing at that - but if they can raise a new round, then this PR won't bring them any extra profit), and any useful effect on the secondary market is too far in future; if there's an investment round happening now, then any potential buyers would be in that investment now; at this point the participating VCs are participating because they want to increase (or at least maintain) their share, not divest it - and if they want to divest after a year or so, the valuation PR effect will have faded. The benefits of such a valuation to the startup, on the other hand, are much more clear.

kcorbitt 8y ago
> VCs generally don't get any meaningful impact from intermediate numbers, they get their numbers - both regarding investor returns and their carry fees - only on exits. The incentives can change if you look one level deeper. VCs often need to start raising a new fund before all the positions in their existing fund are fully liquid. By artificially inflating the valuations of their old fund, they can demonstrate high performance to LPs, which may help them raise more capital for the new fund.
- klank 8y ago
  > By artificially inflating the valuations of their old fund, they can demonstrate high performance to LPs, which may help them raise more capital for the new fund. Where is the line between that and a ponzi scheme? How legal the artificial inflation is? Or is it that the valuation that's being artificially inflated isn't a return per se, but rather highly correlated with returns?
- PeterisP 8y ago
  It's true, however, if we look at what impacts the money that VCs actually get themselves, "help them raise more capital for the new fund" only matters if they're having trouble with raising that round (as I mention in the post above). In normal circumstances, where they can raise the amount the next round should have (i.e. one that they can invest with a good return) this isn't helpful. More capital for the fund doesn't necessarily benefit them - they need enough pledged money for the fund, but if they get the ability to pay twice as much for the same startups, that only decreases their take-home carry after the fact; if they have so much capital that they have to invest it in worse startups just to invest it in the expected timeline - that means worse results and less profit for them; if they raise extra capital for the fund that's sitting unused, then it decreases their overall profitability ratios and again means less profit for the VCs personally. However, if it's difficult for them to get enough investors for the next round (e.g. during an economic downturn) then yes, in such particular cases the PR advantage might be useful. But it's not in most cases, and not now, and the impact isn't that much - the organizations who invest in VC funds (i.e. the limited partners) aren't stupid as well, they can afford to do a lot of due diligence and all the data for the valuations and discussions and doubts about the valuations is available for them. You could just as well argue that if they inflate valuations, then the community of limited partners might think that they're not prudent with their money and avoid investing in their next fund. PR smoke and mirrors works well on the general public, but less well (though not at zero effect) on the large investing institutions.