Protections for Late Investors Can Inflate Startup Valuations

http://www.nytimes.com/2015/06/08/business/dealbook/protections-for-late-investors-can-inflate-start-up-valuations.html

by muzz • 11 years ago

35 16 11 years ago

andyidsinga3• 11 years ago

a lot of this sounds like three comma club problems, however, I'm' trying to connect the dots between the discounts offered to late stage investors and how that affects my one comma club friends and family ..help?

fsk2• 11 years ago

When a late-stage investor gets to invest with a liquidation preference, that can ruin the value of the common shareholders (i.e., early employees) if the startup is not eventually sold for an even bigger valuation.

I.e., the early employees do a great job. The business has a value of $100M and their non-liquid shares are worth $0.5M. The business raises $100M with a 1x liquidation preference. The startup fails, and eventually sells for $50M. Instead of getting $0.1M-$0.25M, those early employees get nothing.

andyidsinga3• 11 years ago

but aren't the unicorns headed for ipo? ..in that case seems anyone with stock options probably does well if the stock doesnt completely tank ?

bzz01• 11 years ago

Frankly it is a bit weird way to describe it. It is not some quirks of liquidation preferences that "ruined" it.

It is ruined by a simple fact that this hypothetical startup earned just 50 cents for every dollar raised -- I don't think anyone should expect a nice payout here.

fsk2• 11 years ago

Suppose an investor pays $100M at a valuation of $1B with a 1x liquidation preference.

Then the REAL valuation of the business is not $1B. It's whatever the investor would have paid for COMMON shares.

rahimnathwani• 11 years ago

tl;dr Startup valuations are usually calculated by multiplying the number of issued shares by the price paid at the last round. This can overestimate the valuation if there are different classes of shares, and the most recent shares have more rights (e.g. liquidation preferences or discounts on future rounds) than do those issued earlier.

x0x03• 11 years ago

I don't know the answer, but doesn't that have to come out in the valuation employees are given? Since there are huge tax penalties both to the employer and the employee for giving in-the-money options, you (in theory) must be given options with a strike set by a 409a evaluation. I think it's best practice to have an arms-length evaluation, since if your cfo sets it and the irs disagrees, see tax penalties. Is this not the state of the world?

mikeyouse• 11 years ago

Yep. Everyone ponies up and pays the $10k/year for the 409a consultants -- in theory, their calculations to establish the option value takes into account all of the liquidation preferences of preferred shareholders but anyone that's been through it can tell you how arbitrary the 409a's really are.

spchampion2• 11 years ago

The article mentions that companies could increase their valuations by increasing the number of shares in the option pool. But how would that work? I'm not seeing the math on that.

cma• 11 years ago

pg: "Yes, investors with preferred stock usually get their money back first. Sometimes they get a multiple, but that's considered overreaching nowadays and the more promising startups never have to agree to that. I suppose that is implicitly a target valuation in a sense. But no one views it as a target, because it only matters if things go badly." https://news.ycombinator.com/item?id=6896833

Protections for Late Investors Can Inflate Startup Valuations

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