The Tech Unicorn Ploy

August 28, 2017

This should not come as much of a surprise— Business Insider reports, “Nearly Half of Tech ‘Unicorns’ Rely on Tricky Math to Land Imaginary Valuations.” So dubbed because they were once rare, “unicorn” startups are ones that have achieved valuations of at least a billion dollars. That is “billion” with a “b.” According to a pair of business professors (from the UBC Sauder School of Business and the Stanford  Graduate School of Business), there are now more than 200 such “rare” prospects globally. Why the apparent boom in unicorn birth rates? Citing a recent study put out by the above-mentioned professors, reporter Alex Morrell writes:

Many of [these startups] are using creative financing maneuvers to conjure imaginary valuation figures that don’t hold up to scrutiny, according to the UBC/GSB study, which examined 116 unicorns. It turns out, when you adjust the valuations to account for guarantees provided to preferred shareholders that dilute the value of common shares, nearly half of unicorns lose their coveted $1 billion status.

The article links to an interview with Will Gornall, the professor from UBC Sauder, that explains how he and co-researcher Ilya Strebulaev re-evaluated purported unicorns to discount the influence of such preferred-shareholder guarantees. They found nearly half sported fake horns, with 11% having been valued at more than twice their fair values. The article continues:

Here’s how it works: In later funding rounds, startups will negotiate a higher share price, but as part of the bargain they guarantee their investors certain protections — such as earning a minimum return on their money or guaranteeing they’ll be paid out in full before all other shareholders. ‘Specifically, we found that 53 per cent of unicorns gave their most recent investors either a return guarantee in IPO (14%), the ability to block IPOs that did not return most of their investment (20%), seniority over all other investors (31%), or other important terms,’ Gornall said. Even though this sort of thing has become normal, valuations haven’t caught up to the fact that providing additional protections to senior shareholders lessens the value of common shareholders. Treating the shares equally can significantly inflate the overall value of the company.

Overvaluation can, of course, help a startup attract funding, talent, and customers. For employees, however, such tactics can end up devaluing their compensation packages. Both workers and investors should be wary of over-valuation trickery.

Cynthia Murrell, August 28, 2017

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