Private valuations are highly suspect

Kevin Kinsella knew it was time to pull the trigger.

Over a series of three transactions leading up to Zynga’s initial public offering in 2011, Avalon Ventures, the San Diego venture capital firm founded by Kinsella, reduced its stake — about 30 million shares — in the San Francisco social gaming company by a third.

It was a gutsy move. At the time, private investors valued Zynga at $14 billion, and its IPO was one of the most hotly anticipated Wall Street debuts of the year. But Kinsella smelled a bubble, at least when it came to Zynga’s valuation.

“Everyone in the bubble can’t believe that it will end,” Kinsella told me recently. “They think it’s different this time. But it’s never different. It always ends.”

Sure enough, during its first day of trading, Zynga stock finished below its opening price of $10 per share, a disastrous debut performance for a new stock. Wall Street now values Zynga at $2.8 billion.

As investors once again push valuations of pre-IPO companies like Uber, Airbnb and Spotify into the tens of billions of dollars, we should

heed the lesson of Zynga. That lesson is this: Private valuations are highly suspect. And though Wall Street has been known to overprice stocks, at least the Securities and Exchange Commission requires companies to release crucial information — such as when major investors decide to dump the stock.

Secrets guarded

Think about it. If you owned stock in pre-IPO Zynga, wouldn’t you want to know that Ava- lon decided to sell 10 million shares before the company debuted on Wall Street?

Such insider trades must, by law, be disclosed on Wall Street, but they are closely guarded secrets in the venture capital world — for a couple of reasons. For a seller like Avalon, even though it clearly felt Zynga was overvalued, the firm didn’t want to spook the market, especially when the company still owned 6.2 percent of Zynga by the time it went public.

“It’s very difficult for venture capital firms to exit should they change their opinions” on a company, said Greg Brogger, founder and CEO of SharesPost, a San Francisco company that enables investors to buy and sell stock in private companies.

Hand-me-down shares

And for buyers like Andreessen Horowitz, which bought into Zynga at a later stage, they don’t want to admit that they are essentially getting someone else’s hand-medown shares.

“They are not going to exactly shout it from the rooftops,” Kinsella said.

Of course, there is some transparency in private markets, thanks to secondary shares platforms like SharesPost, SecondMarket and Nasdaq Private Markets, which crank out data on private stock deals.

For example, SharesPost calculates a fluctuating stock price for a fund that consists of shares in private tech firms like Airbnb, Buzzfeed, Pinterest and Uber. Currently, 517 buyers and sellers use the SharesPost platform, a tiny number compared to a public exchange like NYSE, but that number is “pretty significant” in the private world, Brogger said.

Basic data lacking

“We’re moving in the right direction,” he said.

Still, “more information is better,” Brogger said. When it comes to full transparency of the public markets, he added, “We will probably never get there.” Private companies, by their very nature, don’t have to make financial information public.

And without basic information like sales, profit, executive compensation and inside trades, how will pension and mutual fund investors — whose money the venture capital and privateequity funds use to make these deals — ever know if the 111 companies that make up CB Insights’ Unicorn List are truly worth a combined $404 billion?

We’ll have to wait until the companies go public to see if these unicorns can fly — or bite the dust like Zynga.