Fenwick & West corporate partner Barry Kramer was quoted by BloombergBusiness in an article on billion-dollar technology company valuations that focuses on how investors in hot companies often agree to huge valuations in exchange for beneficial behind-the-scenes agreements.
These agreements might ensure that investors get additional shares if the valuation declines, or free shares if the next valuation round is lower, for example. Or corporate filings might include a senior liquidation preference clause that guarantees that a given group will recoup their investment before anyone else in the event of a problem – if the company finds itself raising additional funds at a lower valuation, for instance.
"When investors are demanding these provisions more, especially things like senior liquidation preferences, that tells me that there's more risk and uncertainty in the market, and they're really protecting themselves," Kramer said, adding, "I don't like to use the word bubble, but it's a sign of concern that valuations are getting too high."
Kramer also noted that a valuation figure based on common stock, which employees usually receive, is generally far more realistic than the investors' valuation, since it is determined by professional auditors.
"It may be 30 percent less; it may be 50 percent less," he explained. "They don't necessarily disclose that to the public until the time of their IPO."