Will Gornall, Professor at University Of British Columbia, and Ilya Strebulaev, Professor at Stanford University discovered that overvaluation of the private venture-backed companies arises because the reported valuations assume all of a company’s shares have the same price as the most recently issued shares.
In practice, these most recently issued shares almost always have better cash flow rights than the previously issued shares, so equating their prices in significantly inflates valuations. [...]
To argue this practice they developed a financial model to estimate the fair value of venture capital-backed companies and of each type of security these companies issue. It is a fully-ﬂedged option-based financial model that derives fair valuation of each class of shares of VC-backed companies, taking into account the intricacies of contractual cash ﬂow terms, using the most recent financing round price and the terms of that financing to infer the value of each of their shares.
The results indicate that post-money valuations are substantially above fair values for many unicorns because of the preferential contractual terms these unicorns gave to their most recent investors. The common shares in such cases are even more overvalued than the company itself.
If you don't have time to read all 54 pages of the study, we prepared for you its major insights.
The model was applied to value 116 unicorns, private VC-backed companies with a reported post-money valuation over $1 billion, at the time of their latest funding rounds.
- All Unicorns are overvalued by at least 5% to a staggering 200%.
- The average (median) post-money value of the unicorns in the sample is $3.5 billion ($1.6 billion), while the corresponding average (median) fair value implied by the model is only $2.7 billion ($1.1 billion).
- This results in a 48% (36%) overvaluation for the average (median) unicorn. Common shares even more overvalued, with the average (median) overvaluation of 55% (37%).
- There is a large variation in overvaluation, but almost one half (53 out of 116) lose their unicorn status when their valuation is recalculated and 13 companies are overvalued by more than 100%.
- The average unicorn in our sample has eight classes, with different classes owned by the founders, employees, VC funds, mutual funds, sovereign wealth funds, and strategic investors.
Top-5 most overvalued companies:
Box: overvalued by 200% (common stock overvalued by 269%)
Good Technology: overvalued by (common stock overvalued by 207%)
Nutanix: overvalued by 200% (common stock overvalued by 269%)
Solar City: overvalued by 178% (common stock overvalued by 206%)
Square: overvalued by 169% (common stock overvalued by 175%)
Top-5 least overvalued companies:
Snap: overvalued by 5% (common stock overvalued by 0%)
Lyft: overvalued by 11% (common stock overvalued by 10%)
Uber: overvalued by 12% (common stock overvalued by 8%)
Bloom Energy: overvalued by 12% (common stock overvalued by 11%)
Jawbone: overvalued by 13% (common stock overvalued by 36%)
Read more about:
How Protective Provisions Affect Valuation Of A Company And Its Common Shares (Liquidation preferences, Seniority, Participation, IPO Ratchet, Automatic conversion exemption, Investment amount, Option pool)
Investors' Perspective And Real Life Examples (SpaceX, Square, Uber and Snap).