There has been much discussion about the high valuations of venture backed companies, and especially the “unicorns”, companies with a valuation of a billion dollars or higher. However, as the investors in these companies generally receive preferred stock, rather than the common stock that is issued in IPOs and held by public company investors, unicorn valuations are not directly comparable to public company valuations.
To better understand unicorn valuations we analyzed the terms of 37 US based venture backed companies that raised money at valuations of $1 billion or more in the 12 month period ending March 31, 2015.
The average valuation of the companies we analyzed was $4.4 billion, the median valuation was $1.6 billion, the average percentage increase per share from the prior financing round was 180%, and the median percentage increase per share from the prior financing round was 100%. Of these financings, approximately 25% were led by traditional VC investors and approximately 75% were led by investors who were not traditional VCs (e.g., mutual funds, hedge funds, sovereign wealth or corporate investors).
Overview of Results
The highlights of our results are as follows:
Our analysis showed that the forgoing terms were used in the following percentage of unicorn financings:
Acquisition Protection Terms
Liquidation protection over common stock – 100%
Senior liquidation protection over other series of preferred stock - 19%
IPO Protection Terms
Minimum IPO price must be no less than unicorn round investment price – 16%
Payment of additional shares if IPO price below unicorn round investment price – 14%
Future Financing Protection Terms
Weighted average – 100%
Ratchet – 0%
*** Analysis:Investors in unicorn financings have significantly more downside protection than public company common stock investors. These protections are especially strong in the event of an acquisition. For example, CB Insights reported that the 10 highest valued unicorns had an aggregate valuation of $122 billion and an aggregate invested capital of $12 billion. Since 100% of the unicorn financings had a liquidation preference, valuations of these companies could fall on average by 90% before the unicorn investors would suffer a loss of their investment, and they could withstand an even greater decline if they had a senior liquidation preference over other series of preferred stock.
IPO protections for investors were less strong. This is probably in part because investors assume that an IPO transaction in and of itself is an indication that a company is doing well, although a unicorn company could be doing well but still go public at a price per share less than the price paid by the unicorn investor. Approximately 30% of unicorn investors had significant protection against a down round IPO.
Future financing protection was present in the form of weighted average anti dilution protection in all rounds. This provides some, but very limited, protection.
Our analysis showed that these terms were infrequently used, as follows:Cumulative dividends – 0%
***Analysis:A result of the significant downside protections and relatively limited upside benefits provided to unicorn investors is that there could be a large range of valuations at which a unicorn could exit, especially by acquisition, in which the unicorn investor would be indifferent because it will not affect its return. For example, if an investor invested in a unicorn at a post money valuation of $10 billion and the company had $1 billion of total investment after such investment, and the investor had the typical non-participating liquidation preference, then the investor would be indifferent if the company was sold at any valuation between $1 billion and $10 billion. This could result in the investor having different strategic interests than investors who have invested at lower valuations. For example the founders and early investors might welcome an opportunity to sell the company at $8 billion, but in that case the unicorn investor might prefer that the company not sell, but rather try to build more value above $10 billion, so that the unicorn investor makes a gain on its investment.
This difference of interests is not unusual in venture capital, but the range of values at which late stage investors are indifferent is much larger than in the past when overall valuations were lower. One way to address this situation is to let founders/management/early investors sell some shares in a secondary transaction to reduce their interest in an early exit. But in most cases, if there is a difference of interest on when to sell the company, the founders/management and early investors will have the voting power to prevail.