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

Abstract

Mutual funds overvalue their junior stakes in startups by 53% compared to fair value models that account for multi-tier capital structures. Junior securities are marked close to senior securities, despite the latter being worth 58% more per share. Mutual funds overpay in secondary purchases relative to model fair values. Overvaluation is not justified by ex-post exit outcomes and does not decline over time or vary with VC boom-and-bust cycles. Mutual funds’ valuation updates are more correlated with model fair values after a down round. The findings suggest mutual funds underestimate downside risks for junior securities while overweighting IPO exit scenarios.

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

JEL Classification: G23, G24, G28, G32