Everyone enjoys a unicorn. These are the young and innovative startups with reported valuations or more than $1-billion (U.S.).
Believe Uber, Airbnb and SpaceX — all highly valued businesses fuelled by investor expectations that they will be the next Google or Facebook.
However, are these rare creatures really deserving of the mythical status?
Will Gornall, assistant professor of finance at the University of British Columbia’s Sauder School of Business, does not think so.
According to a financial model developed by Dr. Gornall and Ilya Strebulaev of Stanford University, many so-called unicorns are overvalued.
Drawing from data included in U.S. legal filings, Dr. Gornall discovered almost half of the startups in their analysis (52 of 116) shed their unicorn standing when their valuation is recalculated. The postings vary, but the typical company reports a valuation 48 percent over its fair value, with average stocks overvalued by 55 percent, the researchers calculate.
Eleven companies are overvalued by more than 100 percent, they conclude.
This overvaluation exists doesn’t surprise Dr. Gornall, that has experience in analyzing the complex deal structures behind early-stage businesses. Miscalculations are made when present valuations don’t include extra perks not found in previously issued shares, so equating their costs significantly inflates valuations.
As an example, the researchers found 53 percent of unicorns gave their latest investors either a return warranty in their initial public offerings, the ability to block IPOs that don’t return most of their investment, or seniority over the other investors, among other important terms.
However, Dr. Gornall admits, “I was amazed at the amount of overvaluation and, moreover, how much it can vary between companies.”
Dr. Gornall says the research doesn’t suggest companies are intentionally misleading folks. However, the findings do introduce widespread confusion around the real value of startups — a specific problem for employees that are often paid partially in stock and options, yet have very little clarity around what those choices are worth.
The problem also extends to investors, he adds, a lot of whom “seem to lack an understanding of the intricacies of venture capital deal arrangements.”
The researchers consider better disclosure in partnership capital-backed businesses, not only unicorns, is required in the USA and Canada, where the federal government is seeking to promote more startup success stories.
More broadly, the analysis provides a lesson in the value of paying attention.
“Whether you’re talking venture capital financing, negotiating a real estate deal or obtaining a loan, you will need to read the fine print and understand the contract,” Dr. Gornall states.
Courtesy: The Globe And Mail