What Drives Startup Valuations?

Abstract

This paper examines the drivers of startup valuations. We analyze monthly pricing data from 223 investments made by 80 distinct funds of 8 U.S. mutual fund managers in 98 privately held and Venture Capital-backed startup companies. Our results are consistent with price ‘anchoring’ and ‘reference point’ theories, showing that external factors such as the valuation of peer companies are a primary driver behind valuations. In contrast, ‘fundamental’ factors such as operating performance indicators play a more muted role. As startups oftentimes experience substantial valuation changes at their Initial Public Offerings (IPO), we also investigate the share pricing transition of startups from private to public companies. We find that more active pricing of shares prior to the IPO results in smaller discrepancies between private and public valuations as well as lower IPO mispricing, suggesting a link between private and public market pricing efficiency. Jointly, our results help investors and regulators achieve a better understanding of the dynamics behind misvaluation in private assets in general, and startups in particular.

Keywords: Mutual Funds, Venture Capital, Unicorns, Private Asset Valuation

JEL Classification: G12, G23, G24, G32