Stanford Business Research on Unicorn Valuations

How do you value a startup? A couple of business school professors looked at 135 billion-dollar companies to find out.

Determining a startup’s worth can be a challenge. Many are fast-growing and unprofitable, and almost all have complex financial structures. They raise funding in multiple rounds, offering investors different restrictions and protections, and therefore stock pricing. The average unicorn, the researchers note, has eight stock classes for different types of investors, including founders, employees, venture capitalists, mutual funds, and others.

Because of that complicated structure, valuation is often based on the latest series’ price, applied to all outstanding shares.

But that doesn’t accurately reflect the preferred treatment some investors might get, the researchers say. In some series, for example, investors are promised 1.5 to 2 times their money should an initial public offering (IPO) fizzle. In that case, other shares can be worth far less.

Silicon Valley’s Unicorns Are Overvalued

Valuing a startup by the latest round price is standard practice in venture.

Our results show that equating post-money valuations and fair values is inappropriate. Although valuation practices are secretive and idiosyncratic, several limited partners (LPs) have informed us that most venture capital funds mark all of their investments to the most recent round’s price. An informal survey of VCs we conducted also suggests that many of them mark up their investments after subsequent successful rounds in their reports to LPs. This is consistent with a memo written for one of the major venture capital firms, Andreessen Horowitz, in which its partner Scott Kupor argues that “[s]ome venture firms value their companies by taking the last round company valuation in the private market and assigning that value to the firm’s ownership in that company.” Moreover, because Andreessen Horowitz uses a valuation methodology that takes into account contractual terms, its “marks are deliberately more conservative and according to our LPs are lower than other firms who use different methods”. Our survey is also consistent with an industry report by the data provider Sandhill Econometrics, which asserts that “in reporting company value, [VC investors] ignore preferences and report all shares at the same value.”

Squaring Venture Capital Valuations with Reality

If you are curious about the list of startups they studied, take a look at their appendix.

Squaring Venture Capital Valuations with Reality: Online Appendix

Auguste Rodin’s The Man with the Key at Stanford.
Photo by Jorge Fernández Salas on Unsplash

Post by Marcelino Pantoja

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