
Protections for Late Investors Can Inflate Startup Valuations - muzz
http://www.nytimes.com/2015/06/08/business/dealbook/protections-for-late-investors-can-inflate-start-up-valuations.html
======
rahimnathwani
tl;dr Startup valuations are usually calculated by multiplying the number of
issued shares by the price paid at the last round. This can overestimate the
valuation if there are different classes of shares, and the most recent shares
have more rights (e.g. liquidation preferences or discounts on future rounds)
than do those issued earlier.

~~~
x0x0
I don't know the answer, but doesn't that have to come out in the valuation
employees are given? Since there are huge tax penalties both to the employer
and the employee for giving in-the-money options, you (in theory) must be
given options with a strike set by a 409a evaluation. I think it's best
practice to have an arms-length evaluation, since if your cfo sets it and the
irs disagrees, see tax penalties. Is this not the state of the world?

~~~
mikeyouse
Yep. Everyone ponies up and pays the $10k/year for the 409a consultants -- in
theory, their calculations to establish the option value takes into account
all of the liquidation preferences of preferred shareholders but anyone that's
been through it can tell you how arbitrary the 409a's really are.

------
cma
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)

------
fsk
Suppose an investor pays $100M at a valuation of $1B with a 1x liquidation
preference.

Then the REAL valuation of the business is not $1B. It's whatever the investor
would have paid for COMMON shares.

------
spchampion2
The article mentions that companies could increase their valuations by
increasing the number of shares in the option pool. But how would that work?
I'm not seeing the math on that.

------
andyidsinga
a lot of this sounds like three comma club problems, however, I'm' trying to
connect the dots between the discounts offered to late stage investors and how
that affects my one comma club friends and family ..help?

~~~
fsk
When a late-stage investor gets to invest with a liquidation preference, that
can ruin the value of the common shareholders (i.e., early employees) if the
startup is not eventually sold for an even bigger valuation.

I.e., the early employees do a great job. The business has a value of $100M
and their non-liquid shares are worth $0.5M. The business raises $100M with a
1x liquidation preference. The startup fails, and eventually sells for $50M.
Instead of getting $0.1M-$0.25M, those early employees get nothing.

~~~
andyidsinga
but aren't the unicorns headed for ipo? ..in that case seems anyone with stock
options probably does well if the stock doesnt completely tank ?

~~~
joshjkim
lotsa folks don't think that many unicorns will actually IPO - here's a good
read that summarizes the potential issues:
[http://abovethecrowd.com/2015/02/25/investors-
beware/](http://abovethecrowd.com/2015/02/25/investors-beware/)

~~~
mycelium
That's really solid article and anyone who has their head in the fundraising
game right now should go read it. Thanks for posting it man.

