Private Valuations Aren't Grounded in Reality, Study Finds (bloomberg.com)

Unicorns aren't real, and neither are the valuations ascribed to many of the startups that say they're worth $1 billion or more, study finds. From a report: About half of private companies with valuations exceeding $1 billion, known as unicorns, wouldn't have earned the mythical title without the use of complex stock mechanics, according to a study by business professors at the University of British Columbia and Stanford University. The tools used to negotiate a higher share price with investors often come at the expense of employees and early shareholders, sometimes drastically reducing the actual value of their stock. The chasm between public and private valuations is a topic of increasing prominence following several disappointing listings. Among them is Blue Apron Holdings, which is trading well below the price venture capitalists paid in the last fundraising round. An often-overlooked explanation for the divide is buried in investor contracts. Blue Apron, which delivers meal kits to customers, gave stock preferences to Fidelity Investments and other backers in 2015 in exchange for a $2 billion valuation. The shares included a provision to receive additional equity if an initial public offering is set below a target price. Investors took advantage of the mechanism after Blue Apron's mediocre IPO.

Comments

Re:It's the economy, stupid

[swillden]

There is no objective measurement of perceived value, which is what the economy runs on.

Nonsense.

You absolutely can objectively measure value, in both individual and aggregate cases. The measurement will not be a single number, it will be a probability distribution, and the distribution will vary over time, but that makes it no less a real, objective measurement. What you're measuring is human demand and desire, and that is a real, objective thing, even if it's variable across the population and across time, and even if it is hard to measure accurately.

If you measured the value of a slice of Wonder bread, you'd find the distribution has a mean on the order of a few pennies, and the vast majority of potential buyers would be willing to buy it for that. There is a non-zero probability you can find someone to pay $10K for it, but it's extremely small unless there's something unusual about your particular piece of Wonder bread. If it's fungible with all of the other pieces of Wonder bread, then the probability approaches zero.

Basically, you're confusing "objective" with "fixed and universal". Objective measurements need not have single values, nor do they have to remain fixed over time or space.

In the case of business valuations, unlike goods there's very little variation (after risk adjustment) across the population, because people rarely have individualistic reasons for wanting to own shares of one company over another. People buy stocks because they hope to make money. On the other hand, business valuations are inherently rooted in predictions of future business prospects. That doesn't make them so much "subjective" as it does "uncertain". Different analysts will assign different probabilities to different outcomes, because forecasting is an unpredictable business. Also, new facts will change the probabilities.

However, aggregate, broad-scale predictions, made by large groups of people tend to produce fairly good results... and that's what stock prices are. Aggregated predictions.

What this study found is that the aggregated predictions of small groups of private investors do not match the aggregated predictions of the public markets, and that the private investors systematically overvalue the companies, as compared to the public markets. Does this mean the private investors' predictions are wrong and the public markets' are right? In one way, yes, by definition, because the private investors ultimately cash out through the public markets, so the private investors are really trying to predict the valuations that will be assigned by the public markets. In another way, no one knows, because the actual value of the company depends on what happens in the future. On average, though, it's likely that the public markets make better predictions.