Fenwick & West’s Unicorn Survey and partner and survey co-author Barry Kramer were prominently featured in an article in The Economist.
The article reported that Fenwick’s survey, which analyzed 37 unicorn deals (financings for startups with valuations of at least $1 billion), found that they all included provisions that minimized the risk of investors losing money by including a liquidation preference clause stipulating that investors are the first to get paid back in the event a company is sold.
Kramer told The Economist that this vastly lower investor risk means that unicorn valuations are not directly comparable with public company valuations, where investors’ money is more vulnerable.
As paraphrased by The Economist, he said, “If a public company loses half of its value, investors lose half of the money they put in […] But should this happen to a unicorn, investors may not lose anything – as long as the total value of the firm does not fall below the amount protected by the liquidation preference.”
These protections are especially strong in the event of an acquisition. Since 100 percent of the unicorn financings included in the survey had a liquidation preference, valuations of these companies could fall on average by 90 percent 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.
Moreover, unicorn deals can potentially set shareholders, including founders, at odds with each other when it comes to deciding on the desirability of accepting a solid take-over offer.
“An investor who has put in money at a high valuation and protected it with a liquidation preference may be less inclined to accept a good takeover offer than earlier investors, including the founders, who may have received shares at a much lower valuation,” The Economist explained. “Worse, liquidation preferences and other terms may mean that founders end up with nothing if their company is sold off very cheaply.”
The full article is available through The Economist’s website.