The valuations that have come out of Silicon Valley in the last few decades have been nothing if not eye-catching: $62.5 billion for Uber, $31 billion for Airbnb, Pinterest at $12.3 billion — you get the idea. And while those are the biggest unicorns — the supercorns — there are currently 135 businesses in Silicon Valley that meet the unicorn criteria: a valuation north of $1 billion.
Just one small problem, according to The New York Times (among others in a loudening chorus). Those valuations may be a bit of myth mixed with some very magical thinking.
And a Stanford University professor is hoping to use math to prove it.
Ilya A. Strebulaev and another professor working with him, Will Gornall of the University of British Columbia, have come to a startling conclusion: whatever valuation a firm gets after fundraising, cut it in half — now you have the actual value. Moreover, they note, once the side deals that go to certain investors are taken into account, almost half of all “unicorns” would fall below the $1 billion threshold.
“These financial structures and their valuation implications can be confusing and are grossly misunderstood not just by outsiders, but even by sophisticated insiders,” Strebulaev and Gornall wrote in a report on their research, describing most private investments as a “black box.”
And that black box has repercussions — particularly for large, institutional public investors like T. Rowe Price and BlackRock that have been investing in unicorn companies in recent years on behalf of public investors. Plus, the researchers noted, large public mutual funds are not really helping at all when it comes to correctly valuing startup worth.
“It is inappropriate to equate post-money valuations and fair values,” the professors said, noting that public funds use the headline price that comes after a round of financing and don’t distinguish between various types of shares.
“Shares issued to investors differ substantially, not just between companies but between the different financing rounds of a single company, with different share classes generally having different cash flow and control rights,” the researchers said.
The people most hurt?
According to the academics, it’s the people who work for the company who don’t realize that the value of the options they had been granted may have little to do with the headline valuation of their employer.
The professors did say they don’t believe that these terms were meant to manipulate investors.