Unicorns maybe less valuable than they claim to be
Uber is said to be worth $62.5 billion. Airbnb is valued at $31 billion. Elon Musk’s SpaceX Technologies is valued at $21 billion, and Pinterest at $12.3 billion.
Those eye-popping valuations regularly fill articles and watercooler conversations in Silicon Valley, all under the umbrella of “unicorn” companies — a term for private companies that are said to be worth more than $1 billion. That moniker now applies to at least 135 businesses, making the descriptions of them as unicorns, well, less apt. (Maybe donkeys?) Early investors and employees spend countless hours calculating and recalculating how much their stake is worth.
Here is some bad news for them: Those valuations may be a bit of myth — or perhaps wishful thinking.
In Palo Alto, California, just down the road from many of the biggest tech companies and the most influential venture capitalists, a professor at Stanford University has quietly been working on a project to crunch the valuation numbers behind some of these private companies.
Ilya A Strebulaev and another professor working with him, Will Gornall of the University of British Columbia, have come to a startling conclusion: The average unicorn is worth half the headline price tag that is put out after each new valuation.
And if the special side deals that most unicorn companies offer to certain investors — more on this sleight of hand in a moment — are taken into account, almost half of the companies 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.”
That black box increasingly has relevance not just to gossips in Silicon Valley, but also to public investors. Big mutual fund companies like T Rowe Price and BlackRock have aggressively begun investing in unicorn companies in recent years on behalf of public investors — yes, you may own a stake in Uber and not even know it — helping to increase the valuations even further.
And even the big public mutual funds, the researchers contend, are not properly valuing the assets. “It is inappropriate to equate post-money valuations and fair values,” the professors said, explaining how, more often than not, public funds use the headline price that comes after a round of financing, and don’t distinguish between various types of shares.
One of the many ways that some companies inflate their valuations, for instance, is by offering certain investors guaranteed valuations in an initial public offering. In other words, if a company doesn’t reach a certain valuation at the time of an IPO, it will issue the investor more shares to make up the difference between the guaranteed price and the one that was attained. Effectively, all the other common shareholders end up paying the difference — and often don’t know it.