It is tempting to read this article as "wah, wah, wah! Nobody values us over a billion dollars!" but it is actually much more insightful. This statement that Jason makes is the key I think ...
" They can afford to get into these bidding wars because they have the confidence that they are likely to at least get their money back, and yet they still get upside exposure if things go extremely well."
There is a lot of 'brand management' at a venture capital company. They want to be the 'cool kids' to the people who 'pick winners.' That keeps the money coming in and the partners paid. Because of that, being an investor in a company that makes a positive, splashy, exit (not necessarily really profitable) helps keep that brand alive.
Given that, when there are already acquisition offers being turned down, VCs no doubt see an opportunity to buff their brand by having a piece of the action. And a weird feedback loop is that founders are quite flattered to hear their company referred to with such high valuations, and it might make their personal fortunes seem large (since they generally still have a large chunk of stock) even though an exit that doesn't clear the preference hurdle will typically pay them little.
So we get this little dance.
Such dreams don't always work out of course. So it is much easier to stay focused on just building value for your customers and adding to their delight and satisfaction in using your products. That activity always pays dividends.
These ultra-high value financing rounds are exits for founders though. Not for all of their stock, sure, but if your company is worth 1B+, you don't need to sell all that much to get a security blanket. So founders are doing these rounds not because it makes their personal fortune seem large, but because it actually allows them to get a mini-fortune (and presumably they think it is good for the company). This happened very publicly with snapchat [1], and I'm sure it happened to many of the other companies listed in the article.
This article also makes it seem like the difference in value between common stock and preferred stock is larger than it is. When a company is small and very high risk, the difference between the common and preferred is extremely large. But as the company value goes up, this gap shrinks by quite a bit, because generally companies with 1B+ valuations have a risk profile closer to a public company than an early startup.
As per the referenced link, I'm not surprised those sorts of deals backfire (where the founder takes money off the table) you lose a lot of urgency when 'rich' is assured (for some definition of rich).
I would hazard that it is unusual for the founders to take a 'soft' exit like this but admit I don't have any numbers to back that up. I know the Groupon founders did and got some harsh press but no long lasting damage.
Of course, when founders take some money off the table, they will no longer be tempted to take the first FU money offer that come along, so will be more willing to push for big home runs.
Correct me if I'm wrong, but what everybody seems to be saying, but not outright, is that early valuations are basically bullshit designed to make everybody think that the company is worth more than it is, immediately after the early valuators got their money in.
Like the guy that buys a car for $2,000, turns around to sell it and tells potential buyers that they can't accept an offer for $4,000 because they'd be taking a loss.
No. There are a few reasons why this isn't an apt characterization:
- Unlike somebody who flips a car, early investors are (typically) not selling their shares to later investors. Investors in different rounds do have differing interests, but they're not diametrically opposed like the interests of buyers and sellers
- The article is about high valuations in late investment rounds, not early ones.
- The reason for the high valuation is that risk in the late-round investments is comparatively low, not that investors want to hype the company for a future round that's even higher.
- To the extent that valuation in late rounds is "bullshit" it's because that valuation really only applies to the investors in the latest round, not to all shareholders. If somebody buys 10% of the company for $200M, we infer that the rest of the company is worth $1.8B, even though you couldn't actually sell it for that price.
If somebody buys 10% of the company for $200M, we infer that the rest of the company is worth $1.8B, even though you couldn't actually sell it for that price.
If I understand correctly, the point is that the latest investor effectively buys between 10% and 100% of the company, depending on what it eventually gets sold for.
Yes, exactly. They have 10% of the shares but they might end up with more than 10% of the proceeds of a sale, if the sale price is less than $2B. That has an impact on the value of the remaining shares.
I think it would be more accurate to say they're getting a promise to pay back their investment with interest (the "bond-like" comment in the article), and also 10% of the company stock. It could turn out that the "bond" is more valuable, or the stock is more valuable, or they're both totally worthless.
A major difference between big early investors and retail investors is that retail investors don't get that "bond-like" guarantee. Hence there's greater risk of loss, and retail investors should value the stock much lower, but frequently don't.
Comments
It is tempting to read this article as "wah, wah, wah! Nobody values us over a billion dollars!" but it is actually much more insightful. This statement that Jason makes is the key I think ...
" They can afford to get into these bidding wars because they have the confidence that they are likely to at least get their money back, and yet they still get upside exposure if things go extremely well."
There is a lot of 'brand management' at a venture capital company. They want to be the 'cool kids' to the people who 'pick winners.' That keeps the money coming in and the partners paid. Because of that, being an investor in a company that makes a positive, splashy, exit (not necessarily really profitable) helps keep that brand alive.
Given that, when there are already acquisition offers being turned down, VCs no doubt see an opportunity to buff their brand by having a piece of the action. And a weird feedback loop is that founders are quite flattered to hear their company referred to with such high valuations, and it might make their personal fortunes seem large (since they generally still have a large chunk of stock) even though an exit that doesn't clear the preference hurdle will typically pay them little.
So we get this little dance.
Such dreams don't always work out of course. So it is much easier to stay focused on just building value for your customers and adding to their delight and satisfaction in using your products. That activity always pays dividends.
These ultra-high value financing rounds are exits for founders though. Not for all of their stock, sure, but if your company is worth 1B+, you don't need to sell all that much to get a security blanket. So founders are doing these rounds not because it makes their personal fortune seem large, but because it actually allows them to get a mini-fortune (and presumably they think it is good for the company). This happened very publicly with snapchat [1], and I'm sure it happened to many of the other companies listed in the article.
This article also makes it seem like the difference in value between common stock and preferred stock is larger than it is. When a company is small and very high risk, the difference between the common and preferred is extremely large. But as the company value goes up, this gap shrinks by quite a bit, because generally companies with 1B+ valuations have a risk profile closer to a public company than an early startup.
[1]: http://finance.yahoo.com/news/snapchats-20-something-founder...
As per the referenced link, I'm not surprised those sorts of deals backfire (where the founder takes money off the table) you lose a lot of urgency when 'rich' is assured (for some definition of rich).
I would hazard that it is unusual for the founders to take a 'soft' exit like this but admit I don't have any numbers to back that up. I know the Groupon founders did and got some harsh press but no long lasting damage.
Of course, when founders take some money off the table, they will no longer be tempted to take the first FU money offer that come along, so will be more willing to push for big home runs.
Correct me if I'm wrong, but what everybody seems to be saying, but not outright, is that early valuations are basically bullshit designed to make everybody think that the company is worth more than it is, immediately after the early valuators got their money in.
Like the guy that buys a car for $2,000, turns around to sell it and tells potential buyers that they can't accept an offer for $4,000 because they'd be taking a loss.
No. There are a few reasons why this isn't an apt characterization:
- Unlike somebody who flips a car, early investors are (typically) not selling their shares to later investors. Investors in different rounds do have differing interests, but they're not diametrically opposed like the interests of buyers and sellers
- The article is about high valuations in late investment rounds, not early ones.
- The reason for the high valuation is that risk in the late-round investments is comparatively low, not that investors want to hype the company for a future round that's even higher.
- To the extent that valuation in late rounds is "bullshit" it's because that valuation really only applies to the investors in the latest round, not to all shareholders. If somebody buys 10% of the company for $200M, we infer that the rest of the company is worth $1.8B, even though you couldn't actually sell it for that price.
If I understand correctly, the point is that the latest investor effectively buys between 10% and 100% of the company, depending on what it eventually gets sold for.
Yes, exactly. They have 10% of the shares but they might end up with more than 10% of the proceeds of a sale, if the sale price is less than $2B. That has an impact on the value of the remaining shares.
I think it would be more accurate to say they're getting a promise to pay back their investment with interest (the "bond-like" comment in the article), and also 10% of the company stock. It could turn out that the "bond" is more valuable, or the stock is more valuable, or they're both totally worthless.
A major difference between big early investors and retail investors is that retail investors don't get that "bond-like" guarantee. Hence there's greater risk of loss, and retail investors should value the stock much lower, but frequently don't.
Thank you for that explanation.