Will Gornall, Ilya A. Strebulaev. Squaring Venture Capital Valuations with Reality (2017-07-11; 2017-04-22 → 2017-07-16). Stanford University Graduate School of Business Research Paper No. 17-29. ssrn:2955455; Abstract ssrn:2968003. 54 pages.
tl;dr → <quote>recently issued shares almost always have better cash flow rights than the previously issued shares</quote> as anyone in the business for more than one series-cycle will be able to tell you.. The valuations claimed out to the Muggles are inflated, by (average) 49%-59% and upwards unto 100% and beyond.
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 49% above its fair value, with common shares overvalued by 59%. In our sample of unicorns – companies with reported valuation above $1 billion – almost one half (53 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.
Gornall, Will and Strebulaev, Ilya A., Squaring Venture Capital Valuations with Reality (July 11, 2017). Stanford University Graduate School of Business Research Paper No. 17-29. Available at SSRN: ssrn:2955455.