Do Investors Overvalue Startups? Evidence from the Junior Stakes of Mutual Funds

56 Pages Posted: 1 May 2023 Last revised: 27 Nov 2023

See all articles by Vikas Agarwal

Vikas Agarwal

Georgia State University - J. Mack Robinson College of Business; University of Cologne - Centre for Financial Research (CFR)

Brad M. Barber

University of California, Davis

Si Cheng

Syracuse University - Department of Finance

Allaudeen Hameed

National University of Singapore (NUS) - Department of Finance

Harshini Shanker

London Business School

Ayako Yasuda

University of California, Davis - Graduate School of Management

Date Written: April 21, 2023

Abstract

We show that mutual funds report their junior stakes in startups at 43% higher valuation than model fair values that consider multi-tier capital structures of startups. The latest-issued and most senior security is worth 48% per share than junior securities held by mutual funds, implying that mutual funds mark junior securities close to par with the senior securities. Our findings are robust to model assumptions. Identical valuations reported for dual holdings of senior and junior securities imply 37% discrepancy in implied values of the firm. Overvaluation is lower for fund families with longer experience in private startup investments, and higher for junior securities purchased in secondary transactions. Overvaluation declines after down rounds (new financing rounds with purchase prices lower than previous rounds) and near IPOs. The results are consistent with mutual funds neglecting the probability of negative outcomes in which junior securities are paid less than senior securities and overweighting successful exits where all securities convert to common equity and are valued equally.

Keywords: Startup valuation, Mutual funds, Venture capital, Fair value, Private valuation

JEL Classification: G23, G24, G28, G32

Suggested Citation

Agarwal, Vikas and Barber, Brad M. and Cheng, Si and Hameed, Allaudeen and Shanker, Harshini and Yasuda, Ayako, Do Investors Overvalue Startups? Evidence from the Junior Stakes of Mutual Funds (April 21, 2023). Available at SSRN: https://ssrn.com/abstract=4425744 or http://dx.doi.org/10.2139/ssrn.4425744

Vikas Agarwal

Georgia State University - J. Mack Robinson College of Business ( email )

35 Broad Street,
Suite 1234
Atlanta, GA 30303-3083
United States
404-413-7326 (Phone)
404-413-7312 (Fax)

HOME PAGE: http://https://sites.google.com/view/vikasagarwal

University of Cologne - Centre for Financial Research (CFR) ( email )

Albertus-Magnus Platz
Cologne, 50923
Germany

Brad M. Barber

University of California, Davis ( email )

Graduate School of Management
One Shields Avenue
Davis, CA 95616
United States
530-752-0512 (Phone)
530-752-2924 (Fax)

Si Cheng

Syracuse University - Department of Finance ( email )

Whitman School of Management
721 University Avenue
Syracuse, NY 13244
United States

HOME PAGE: http://si-cheng.net/

Allaudeen Hameed

National University of Singapore (NUS) - Department of Finance ( email )

Mochtar Riady Building
15 Kent Ridge Drive
Singapore, 119245
Singapore

HOME PAGE: http://bizfaculty.nus.edu.sg/faculty-details/?profId=1

Harshini Shanker

London Business School ( email )

Sussex Place
Regent's Park
London, NW1 4SA
United Kingdom

Ayako Yasuda (Contact Author)

University of California, Davis - Graduate School of Management ( email )

One Shields Avenue
Davis, CA 95616
United States
530-752-0775 (Phone)
530-752-2924 (Fax)

HOME PAGE: http://www.ayakoyasuda.com

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