Over the past several years, unicorns have evolved from isolated rarities into a thundering herd, with valuations seemingly too good to be true.
Turns out the values may be just that, too good to be true, according to a study by a pair of university professors.
The two came up with a formula for measuring the worth of these billion-dollar-plus companies that takes into account the deal terms offered in later rounds, such as IPO ratchets and downside protections, such as senior rights.
What they found was that the average unicorn has been marked up 51 percent above its fair value, with 13 of the 116 companies examined overvalued by more than 100 percent.
One example is Square, which they found was valued in an October 2014 round 171 percent above a fair value. The study recalculated the company’s $6 billion post-money valuation to be $2.2 billion, similar to its pre-IPO value about a year later.
Another company is Kabbage, which was valued in a June 2015 round 138 percent above fair value, and a third is Nutanix, valued 156 percent above fair value in its August 2014 round.
“Equating post-money valuation with fair valuation overlooks the option-like nature of convertible preferred shares and overstates the value of common equity, previously issued preferred shares, and the total company,” the study argues. “IPO ratchets and other contractual terms inflate valuations.”
The analysis was put together by Ilya Strebulaev, a finance professor at the Stanford University’s Graduate School of Business, and Will Gornall, an assistant professor at the University of British Columbia’s Sauder School of Business in Vancouver.
The study acknowledges that valuing private companies is difficult, and not simply because of the challenges of determining the worth of high-growth, illiquid companies, but because the companies create new classes of equity every two years or so when they raise money.
The average unicorn in the sample issued eight classes of stock with different classes for founders, employees, venture investors, mutual funds, strategic investors and sovereign wealth funds.
It also throws into question the valuations many venture capitalists and co-investors typically place on the companies. These valuations usually treat all classes of stock equally and mark up a company after a new round of financing is complete without considering contractual terms.
The study reported that 53 of the 116 companies, or nearly half, lose their unicorn status when the new formula is applied. It pushes the average $3.66 billion post-money valuation of the unicorns down to $2.8 billion, and notes that some of the companies offered such generous rights to their preferred shareholders that their common shares are nearly worthless.
On the overvalued list are SpaceX (found 64 percent too high), Flipboard (found 96 percent too high), Compass (found 202 percent too high) and HomeAway (found 110 percent too high).
One company to emerge relatively unscathed in the study is Uber, overvalued in a May 2016 round by a relatively small 12 percent. Its investors were granted no rights to obstruct an IPO in the round, though they did get liquidation preferences. The adjustment brings Uber’s $68 billion valuation at the time to $60.6 billion.
Airbnb and newly public Snap also are spared big markdowns in the study, with Airbnb’s valuation in a December 2016 round recalculated to $26.1 billion, or 15 percent less than the $30 billion valuation assigned at the time. Snap’s valuation in an October 2016 round was just 5 percent too high at $20 billion instead of $19 billion.
Lyft and Palantir also came out well.
Photo of unicorn courtesy of MadKruben/iStock/Getty Images