
New research indicates ‘Unicorns’ are overvalued - good_vibes
https://www.gsb.stanford.edu/insights/silicon-valleys-unicorns-are-overvalued
======
cjlars
The key issue is that a lot of startups use various contractual terms --
things like options on exit, liquidation preferences and others -- to take
money into into the business at high nominal valuations, while still offering
downside protection (optionality) to investors. The public at large usually
just quotes the nominal valuation and goes from there. However, the
optionality of those terms has substantial financial value, so the nominal
valuation is often far from the truth.

These authors have developed a system to tease out the optionality using
standard financial methods (using methods like Black-Scholes, for example),
which can give us all a better understanding of the true worth of these
companies. Far overdue in my opinion.

~~~
bogomipz
>" while still offering downside protection (optionality) to investors."

I'm not familiar with tern "optionality" can you say what that is and how it
provides downside risk protection to investors? Thanks.

~~~
gjem97
The optionality in startup investing has mainly to do with the "limited
liability" in Limited Liability Corporation (other types of corporations and
partnerships also have limited liability). That is, if you invest a dollar in
a corporation, your losses are capped at a dollar. But, your gains are
potentially infinite. Another instrument that has that characteristic--limited
downside and infinite upside--is an option. The startup equity isn't actually
an option, but it is useful to discuss its "optionality" because it does have
some similar characteristics.

~~~
bogomipz
Thanks for the explanation.

A related question I have then is would RSUs be considered as providing
downside risk(but no upside) for employees then as the value is independent of
the companies actual performance?

~~~
jsjohnst
I'm far from an expect, but unless I'm misunderstanding your question, no,
that's not it. RSUs negate some of the downside risk for an employee (vs an
option), but have similar upside. With an RSU, it has value as long as the
company has value, with an option, it has no value unless the sell price is
above the strike price.

~~~
bogomipz
I probably didn't articulate that as well as I could have. You answered my
question though thanks. I actually don't hear about RSUs as much except for
some unicorns that seem to be staying private for longer and longer.

~~~
jsjohnst
Many publicly traded companies issue RSUs over options these days. But yeah,
many startups don't.

~~~
bogomipz
Yes, I think that RSUs are the most common form of stock grants for publicly
traded companies. I think FB might hae been one the first SV companies to use
it for employees pre-IPO.

------
gjem97
> The average unicorn, the researchers note, has eight stock classes for
> different types of investors, including founders, employees, venture
> capitalists, mutual funds, and others.

As an aside, this is why I think that any effort of a prospective employee to
divine the value of a stock option package is likely in vain. Without a
detailed accounting of the ins and outs of the preferred stock that is senior
to your common shares, it is nigh impossible to tell how much the common
shares (and options thereon) are worth.

~~~
mbesto
This is why I always recommend to individuals that when a startup offers
equity in lieu of cash compensation to ask every financial/equity question
imaginable. (what are you valued at today? how much investment have you taken?
what's been diluted? etc etc)

People don't like to have that conversation because they think it's
inappropriate. However, it's more inappropriate for a founder to tell you that
you're getting equity in lieu of compensation and explain nothing about the
value of that equity and potential future value of that equity based on the
current state and future state assumptions.

~~~
GuiA
90% of my engineer/designer friends have no clue what every financial/equity
question imaginable even look like, and even if they had a list of them,
they'd have no clue about how to interpret any of the results, or how to tell
if the company is feeding you BS.

I mean, I was the first employee at a startup, involved with fund raising, and
then founder at a startup, and even I would have a hard time with that.

Not to mention that even if you have a very solid understanding of what things
are like when you get hired, it can all change dramatically in subsequent
fundraising.

This is just one of many instances where the employee/employer relationship is
heavily biased against the employee. And unless clear disclosure requirements
understandable by the average worker are put in place, it'll stay that way. As
an employee, your options are inscrutable lottery tickets which value can be
redefined in many ways at many points in time, and there's not much you can do
against that.

~~~
mbesto
> 90% of my engineer/designer friends have no clue what every financial/equity
> question imaginable even look like

Totally - I've been thinking about actually putting on a "equity master class
for engineers looking to join startups" type seminar in the bay area if people
are interested.

~~~
mbesto
Seems like there's some interest for this. If people legitimately want to know
more, please let me know here:

[https://goo.gl/forms/j70V7ew5Dds7AoOt1](https://goo.gl/forms/j70V7ew5Dds7AoOt1)

If there's enough interest I'll put something on.

PS - By way of background, I work in tech M&A and regularly see cap tables,
equity packages, salaries etc. both in and out of SV.

------
arjie
I think when a model is presented like this, it should also show the examples
where it fails. In the article, they show Square (Series E valuation at 6 B,
pre-IPO 2.66 B) where the "fair valuation" correctly models closer to pre-IPO
at 2.2 B.

However, let's look at another example. Take Nutanix (Series E valuation at 2
B, pre-IPO at 2.1 B). This model values it at 0.8 B on their table, almost a
third of the IPO price.

There is no explanation forthcoming in this article as to why that's the case.
This makes it seem like the Square example was cherry-picked.

I picked NTNX at random, so I don't know if it's the one exception. I'm not
going to exhaustively check every result, however. I expect them to do that
for me and not sell me a story without pointing out the terrible exceptions.

~~~
gjem97
This is why the myth of "market capitalization" is so persistent. Often what
you have at an IPO is a conversion of preferred shares to common shares. So
effectively the 8 classes of preferred shares do become the same as the
common, and the "simple" market capitalization number becomes real.

However.

How many startups never IPO? 99%? 99.9%? In acquisition or liquidation
scenarios, those common shares are often worth a lot less than preferred. And
because these scenarios make up a large proportion of the probability
distribution, it means the expected value of common shares is a lot lower.

Even unicorns that are far more likely to IPO can raise bridge rounds that
cause major dilution for the common shares, rendering previous market
capitalization numbers useless.

------
sebleon
The deal terms for unicorn investment rounds are less about company
fundamentals, and more about the scarcity of great startups.

There's more money than there are good deals in Silicon Valley, so later stage
investors are forced to offer more money for less equity in order to beat
other term sheets. This ends up looking like sky-high valuations, since
investors that offer fair-market-valuations are unlikely to get picked.
Founders naturally gravitate towards minimizing dilution.

~~~
johan_larson
_There 's more money than there are good deals in Silicon Valley, ..._

Is that true? VCs aren't acting the way they would if they really believed it.
If they did, they would refuse funds from potential LPs, since they really
can't find professionally responsible places to invest it. But that's not what
they do. Alternately, they might take the LPs' money, warn them carefully that
they could be investing in some real longshots, and then be willing to invest
on fairly generous terms in any number of startups that look to be competently
run and pursuing plausible opportunities. But that's not what they do, either.

Something doesn't add up.

~~~
moxious
The VCs of course need to maintain return but they are under some pressure to
push money out the door and invest, as their fee is a percentage of funds
invested.

There are many funds structured in a way where it's better for the fund (not
necessarily for the investor) to invest 2x in questionable companies, than
just 1x in great companies, lest they lose fees on the remainder.

------
WestCoastJustin
If you are looking for the table of companies, like I was, then download the
report via
[https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2955455](https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2955455)
and skip to page 48.

------
neom
I was fundraising last year for the company I work at and one of the investors
asked me if I'd consider doing XYZ. I said, well that would put our share
price to such that you would create a massive valuation on the business, so
no. They seemed confused and said but wouldn't you want to make the company
that valuable. I smiled and ended the meeting. What they wanted would
introduce an enormous amount of risk to the business because Valuation !=
valuable. I would imagine this type of conversation is how founders end up on
that list. I think our business is great, but I'm not delusional.

~~~
gogopuppygogo
Was this DO you were fundraising for? I would think sky high valuation for
something that large would be exactly what founders want.

~~~
neom
No, fundraising for DO wasn't like I've ever seen before as the revenue growth
and customer growth was straight up and to the right when I joined (~employee
15). This was for the startup I founded after I left DO:
[https://techcrunch.com/2017/05/24/stae-helps-cities-take-
adv...](https://techcrunch.com/2017/05/24/stae-helps-cities-take-advantage-of-
their-data/)

------
artellectual
The key thing here isn't about the fact that they are overvalued. It's more
important to discuss the repercussions and what anyone is doing about it. It's
not just Sillicon Valley, it's the startup scene all over the world.

How much is something really worth. Well how much is the next person willing
to pay, that's really what this is all about. I've been down the road of VCs,
exits etc... before and to be honest most of it is just fluff people make up,
loop holes in the way things are valued, forget basic business and accounting
they literally are making this up as they go.

Most VCs I feel have a detrimental effect on startups, the only thing a lot of
them provide is money, which isn't always what a startup needs. It doesn't
matter to the VCs that they are mostly wrong, they just have to be right once.

The question we need to ask here is what happens when it all crumbles down,
due to the fact that all this is going on. How valuable something is
ultimately depends on how many lives it improves. Whether something is
valuable or not is measured by the amount of pain inflicted on society if the
startup didn't exist, and ultimately if something is not needed, it wont
survive anyway. The market is cruel like that, and having VC money shields
entrepreneurs away from that crucial factor. All this fluffed up valuation has
nothing to do with the survival of a business anyway.

~~~
ethbro
_> The question we need to ask here is what happens when it all crumbles down,
due to the fact that all this is going on._

The problem there is that anyone riding right up until the very end has a
pretty substantial return advantage over the folks who stepped off early and
turtled up.

Which gives a perverse incentive to stay all in, which gives everyone an
incentive to keep the wheel spinning for as long as possible, which is
probably why crashes only tend to happen with an external spark.

------
singaraja
Square is valued at 8.69B in
[https://beta.finance.yahoo.com/quote/sq](https://beta.finance.yahoo.com/quote/sq)

So if this article is to be trusted it is overvalued by 4.4 B $. that is
another square.

------
dmourati
May I recommend anyone wishing to understand more about valuation read the
book Venture Deals?

[https://www.amazon.com/Venture-Deals-Smarter-Lawyer-
Capitali...](https://www.amazon.com/Venture-Deals-Smarter-Lawyer-
Capitalist/dp/1119259754/ref=dp_ob_title_bk)

The subtitle is tongue in cheek but also gives you a sense of how much you can
learn and how rare company you are in once you understand the details.

------
surrealize
If you've been an employee at a unicorn and have common shares/options, check
out table 8 (page 48) that lists common share valuations according to their
model.

AIUI, the common share FMV they list should be comparable to the 409A common
share valuations you may have gotten. Roughly speaking, assuming the funding
round in the table is close in time to the 409A valuation.

------
markm248
New research indicates lottery tickets are overvalued.

------
NumberCruncher
Evergreen: [https://m.signalvnoise.com/press-release-basecamp-
valuation-...](https://m.signalvnoise.com/press-release-basecamp-valuation-
tops-100-billion-after-bold-vc-investment-c221d8f86ad7)

------
pascalxus
The subject title seems about right, but I take issue with the use of the word
"new". they just found this out?

Nevertheless, it's not that much: 50-100%. that's hardly a dot-com bubble
bust.

------
TrickyRick
Perhaps this is the beginning of the end of what is essentially a new IT
bubble? After all, it bears all the traits of the last bubble so all that's
missing is a trigger.

~~~
akuji1993
Will be probably happen. I guess the trigger will be something like Twitter
going down under and not getting VC the payment that they WILL WANT in some
close future. I guess then comes a few years of VC being a lot more cautious
where it's going to be harder to sell your company idea to them. It's phases
all the time and we're on a high right now.

~~~
TrickyRick
Although right now money is so cheap and there isn't really any alternative if
you want ROI. That said, US interest rates are on the rise more so than those
in Europe so perhaps the end might come sooner than most people think.

------
theprop
More details on how they calculated everything would be nice. A better place
went bankrupt!

------
hectorr
Maybe all asset classes are undervalued relative to the currencies they are
priced in.

------
tomblomfield
TL;DR it is not fair to take the per-share valuation at the last round of
funding and apply it to all stock if the newly issued stock has preferential
rights.

10 apples are worth $100. 90 oranges are not therefore worth $900.

~~~
akud
Well, also that the act of creating the apples devalued the oranges.

------
skdotdan
You don't say?

------
fs111
news at 11

------
maxehmookau
Bears shit in woods. Pope catholic.

------
romanovcode
Wow, in other news - sky is blue!

------
EGreg
This is what Edgser Dijklmnopqstra was saying back before these unicorns
existed.

We have drifted far from the vision of people building up computing.

------
gcb0
you know how Nigerian scammers write bad English on purpose so they don't draw
smart people by mistake and waste time dealing with them?

unicorn valuation is the same mechanism.

do it so obviously wrong that you only draw dumb people who think they are the
only ones smart enough to see the valuation is off so they buy thinking they
can profit from their clever and unique insight. and the scam is complete.

------
charred_toast
Yeah, when fucking websites are worth more than real estate it takes a genius
to figure out there is something amiss. /s

