There has been a great deal written about the growing number of venture backed companies with billion-dollar valuations. While valuations are clearly high (see our recent survey at www.fenwick.com/vcsurvey for details) discussions about venture valuations can be misleading, because the valuation of a venture backed company needs to be analyzed very differently than the valuation of a public company.
The reason for this is that in a venture backed company investors receive preferred stock, which gives them important rights that holders of common stock (which is the type of stock issued in IPOs) don't receive. So it's important to understand those additional rights to understand a private company's valuation.
For example, preferred stock almost always entitles the investor to a liquidation preference, which provides that the investor is entitled to receive its entire investment back before common stock holders such as management and employees are entitled to receive any return, and in most cases before other investors are entitled to receive any gain on their investment.
This can have huge implications. For example CBInsights has recently listed the 10 highest value VC backed companies. These companies had an aggregate valuation of $122B, and an aggregate amount invested in them of $12.1B, approximately 10% of their valuation.
This means that, because of the preferred stock liquidation preference, these companies could fall an average of 90% in value before their investors lost any of their money.
And there are other types of preferred stock terms, such as anti-dilution protection, IPO auto convert thresholds and senior liquidation preference, that can also be used to reduce the downside of a late-stage, high valuation investor.
So while there are certainly a number of VC backed companies receiving very high valuations, it is important to not compare these valuations to public company valuations, where the investor owns common stock, and a 90% decrease in the value of the company means the investor loses 90% of its investment.