Create Your Own Valuation

Abstract

I find noticeable bunching in venture capital (VC)-backed company valuations at $1 billion, the minimum threshold to be a so-called unicorn. I ask how VC-backed companies strategically inflate their valuations and why. Exploiting a unique practice whereby reported valuations include authorized but unissued stock options, VC-backed companies authorize more shares for future employee compensation to achieve unicorn status. Rank-and-file employees, one of the most important stakeholders of VC-backed companies, interpret unicorn status as a positive signal. Contrary to employees’ interpretation, however, inflating valuations to achieve unicorn status lowers the expected value of their stock options, raising concerns about the information asymmetry employees face.

Keywords: Startup, Venture Capital, Valuation, Stock Option, Human Capital

JEL Classification: G24, G32, L26