

Y Combinator tally: 511 startups, $11.5B valuation - rainmaker23
http://www.bizjournals.com/sanjose/news/2013/05/28/y-combinator-tally-511-startups.html

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keithwinstein
My understanding is that these "valuations" are calculated by taking the price
per share of the most senior tranche of preferred stock and multiplying that
by the total number of shares outstanding (+ the option pool) of all classes.

This kind of "valuation" may be useful and the way business is done, so if
everybody is wise to the game, it's not clear anybody who matters is being
deceived. But as far as an outsider or accounting geek is concerned, this is
not an appropriate way to value the equity in a company with multiple share
classes. Common shares and less-senior preferred shares are simply not as
valuable as the most senior preferred stock. You can't apply the same per-
share value to everything.

These same companies are not claiming $11.5 billion of "valuation" when they
set a per-share value for 409(a) purposes. In broad strokes, these companies
claim to have low valuations to the IRS (which helps their employees when they
grant options) and high valuations to the press (which helps them look good
and attract employees) at the same time.

Which may all be fine, but the press (and prospective employees) should be as
wise to the game as the investors and company are.

~~~
grellas
When preferred stock investors calculate the value of a company, they do so
with reference to a cap table showing the fully diluted capitalization of the
company (that is, all classes of stock plus options) assuming that all stock
is converted to common and all options exercised.

In this way, a lead investor investing, say, $4M in an A round with a $6M pre-
money company valuation and paying $1/sh against a model of 10M authorized
would own 40% of a $10M company (post-money valuation), would own 4M shares of
Series A preferred stock valued at $1/sh, and would do so in a context where
there may be, say, 4M common shares held by founders and 2M common shares held
in a pool for equity incentives. When that same company goes to do its 409A
valuation following that preferred round, it retains an outside independent
valuation company to calculate the price of its common stock for purposes of
valuing options granted to employees (409A is solely designed as a compliance
provision requiring that options and other forms of deferred compensation
granted to executives and other employees not be underpriced as of the date of
grant). When it does that valuation, the outside company will measure the
value of the common stock by looking at the arms-length deal done by the
Series A investors by which they paid $1/sh that gave them each 1 share of
preferred stock that is typically convertible 1:1 into common stock on the
happening of certain events. As of the date of the Series A investment, that
common stock clearly does not have the same value as the preferred stock
because the preferred stock includes a series of valuable preferences that the
common stock lacks (e.g., a liquidation preference giving it first preference
in being paid the proceeds of any acquisition, subject to various limitations;
a right to class approval of major corporate actions; a right to anti-dilution
protection in the event of a down round, etc.). Any common stockholder who has
been "wiped out" in a merger where the preferred holders take everything and
the common holders get nothing can attest to the value of these preferences.
This is why the stock is called "preferred" in the first place. In any case,
in the days before 409A, a company's board of directors would routinely use a
10:1 ratio to value the preferred stock in relation to the common owing to the
value of the preferences (that is, in our example above, the preferred stock
would be priced at $1/sh and the common at $.10/sh). Since the enactment of
409A, that ratio has shrunk considerably and, today, the outside companies who
do the valuations will at their most aggressive use a 5:1 ratio and will much
more typically use more like a 3:1 ratio in accounting for the valuation
difference (again, in our example, resulting in common stock prices of $.20/sh
and $.33/sh respectively). The common stock valuation so determined will then
be used by the company for valuing its stock options granted to employees.
After such options are granted, should the company hit the skids and go down
(or get acquired in a fire sale), the common stock holders would typically get
nothing while the preferred holders may get some or all of their money back.
On the other hand, if the company does very well and is ultimately acquired at
a premium, then the preferred holders (in a typical case where the preferred
stock is non-participating and only gets its money back on the liquidation
preference without participating in any further payout) will convert to common
in order to get the benefits of the acquisition and will share equally (in
accordance with their percentage interest in the company) with all other
common holders in those proceeds. In this way, in the end, the discounted
value of the common stock as used for 409A purposes becomes irrelevant to the
value of the company and what really counts is the arms-length price that
someone will pay for the acquisition, as to which the common will share
equally with the preferred. In other words, there was a reason for discounting
the value of the common at the time of the A round but that reason goes away
once the acquisition occurs and that event in turn establishes the pricing for
common stock at the new premium price without regard to what the 409A price
was in different circumstances.

This is why it is legitimate for company valuations to be based on the latest
preferred pricing spread against the fully diluted capitalization of the
company. It is not inconsistent to use that approach for the overall valuation
of the company while using a discounted approach for 409A purposes. They are
two different measures, each used for a distinct purpose, and are quite
compatible with one another.

Hope this helps explain the technical points involved.

~~~
keithwinstein
I agree with your description of the mechanics, but not with your conclusion
that "there was a reason for discounting the value of the common at the time
of the A round but that reason goes away once the acquisition occurs" and that
"it is legitimate for company valuations to be based on the latest preferred
pricing."

That analysis assumes that the acquisition will occur at a price that makes it
worthwhile for the preferred investors to convert their shares to common, and
therefore that the preference will be irrelevant.

Of course _if_ there is a tender at a high-enough price, _then_ the common
shares will be worth the same as the preferred. But until that occurs, the
preference is valuable. After all, the point of the preference is that it's a
hedge against an uncertain outcome -- in this case, an acquisition that takes
place at less than the original price of the preferred shares.

That's why you can't properly value the equity in a company by multiplying the
price of the most valuable kind of shares by the total number of shares
outstanding. In the presence of uncertainty about the value of a future
buyout, the shares that don't have the preference really are worth less.

Fortunately, the company does not really claim this fake-valuation as its
value anywhere that matters -- only when boasting to the press and to
prospective employees.

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canttestthis
I've asked this before but does anyone know (or has anyone bothered to
calculate) the median valuation of YC companies?

~~~
jcampbell1
The median value is likely around $0. A 30-40% success rate would be amazing,
yet still show a median valuation of $0.

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zan
On a completely unrelated note - has anyone noticed the numbers actually form
a palindrome?

~~~
Hitchhiker
to clarify Zan's comment its

511 ( startups ) 11(.)5 (B)

for it to be one " startups " , decimal and B have to be parsed out ;-)

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pdq
And what percent of that can we assume Paul owns? He certainly is a rich man.

~~~
gline
I think YC takes mid single digit percentages in some form early on? So you
figure they get diluted down over time and maybe they have, as a firm, 1-2
percent of the total, so, maybe, 150-250mm? And then PG certainly has a big
chunk of that - a quarter? A third? He was already pretty rich because he got
Yahoo stock (in substantial amounts!) for selling Viaweb, and then Yahoo stock
went on to increase by a factor of more than 10 to its peak - if he had 20% of
Viaweb at sale (10mm on the day of the transaction) and got out at a
reasonable time he had, say, 75mm by the early part of last decade...

All of which is to say, it's true that YC has been very successful for all
parties, and PG is probably much richer now than he was when he started it,
but I suspect he'd say the money wasn't the important thing to him and based
on these numbers I'd be inclined to believe him.

Edit: incidentally, I think PG has probably been underpaid for his YC work - I
suspect most investment firms do not add substantial value to the companies
they invest in, but the YC brand is clearly enormously influential and, given
the enormous amount of noise in startup-land, I bet the brand - which PG has
worked on very carefully for years - is responsible for a meaningful
percentage of the value of the portfolio.

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tomasien
I like that there's kind of a subtle dig to the post-Jobs Apple in there.

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Jun8
What is this talk in the article about pg leaving YC? Oh God, please don't let
that happen before I get in!

I think it _would_ be bad for YC (and to a lesser extent HN), if not
disastrous.

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danso
> _The difference between me and the other partners is mostly that I got to be
> publicly known by writing._

I wonder what the rate of Y Combinator founders' blogging (either personally
or placing importance on their official business' blogs) vs those outside of
it, if such a thing could be quantified.

