Squaring Venture Capital Valuations with Reality

55 Pages Posted: 22 Apr 2017 Last revised: 16 Aug 2017

Will Gornall

University of British Columbia (UBC) - Sauder School of Business

Ilya A. Strebulaev

Stanford University - Graduate School of Business; National Bureau of Economic Research

Date Written: July 12, 2017

Abstract

We develop a financial model to estimate the fair value of venture capital-backed companies and of each type of security these companies issue. Our model uses the most recent financing round price and the terms of that financing to infer the value of each of their shares. Using data from legal filings, we show that the average highly-valued venture capital-backed company reports a valuation 48% above its fair value, with common shares overvalued by 55%. In our sample of unicorns – companies with reported valuation above $1 billion – almost one half (52 out of 116) lose their unicorn status when their valuation is recalculated and 11 companies are overvalued by more than 100%. Overvaluation arises because the reported valuations assume all of a company’s shares have the same price as the most recently issued shares. In practice, these most recently issued shares almost always have better cash flow rights than the previously issued shares, so equating their prices significantly inflates valuations. Specifically, we find 53% of unicorns have given their most recent investors either a return guarantees in IPO (14%), the ability to block IPOs that do not return most of their investment (20%), seniority over all other investors (31%), or other important terms.

Online Appendix is available at https://ssrn.com/abstract=2968003.

Keywords: Venture Capital, Unicorns, Valuation, Entrepreneurship, Startups

JEL Classification: G24, G32

Suggested Citation

Gornall, Will and Strebulaev, Ilya A., Squaring Venture Capital Valuations with Reality (July 12, 2017). Stanford University Graduate School of Business Research Paper No. 17-29. Available at SSRN: https://ssrn.com/abstract=2955455

Will Gornall (Contact Author)

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Ilya A. Strebulaev

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

HOME PAGE: http://faculty-gsb.stanford.edu/strebulaev/

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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