EPISODE 029 – UNICORN MANIA, The Real Facts About Post-Money Valuation

Distilling Venture Capital

UNICORN MANIA, The Real Facts About Post-Money Valuation

Post-Money Valuation; The Facts

• It is absolutely NOT the market capitalization or market value of a tech unicorn company;
• PM Valuation completely ignores all the prices paid, preferences, and rights granted, for ALL prior rounds – a major flaw and a farce;
• Thus, a completely distorted picture of value is created by actually assuming that all of these past preferred rounds of equity, plus common, are all magically worth the same price as the round just completed. This is insanity;
• To make matters worse, The derivation of the PM Valuation is cloaked in secrecy – it´s a black box - you don´t get to see the calculation!
• Remember, from the Stanford Study, ALL 135 Unicorn companies evaluated were overvalued using the PM Valuation AND, 65 lose their Unicorn status!
• This is a ‘Houston-we-have-a-problem’ moment. If these statistics aren’t an indicator that something is terribly wrong with the PM Valuation...well…then you are in Unicorn land.

A Unicorn Index Fund is a Sham

Given the above facts, the concept of a Unicorn Index, then, is a sham based on this faulty method of valuation. The indexes, in fact, do not have visibility into the requisite information and data actually needed to return a market value or market capitalization (i.e., financial statements). That´s why they use the inappropriate and discredited PM Valuation and then try to sell it to you as some rigorous and proprietary methodology. Complete BS.

• Since these index funds have very limited information in these private companies (again, no fin. statements), they are trying to triangulate a valuation from incomplete information and back-of-the-envelope approach.
• It turns out, based on the research, the PM Valuation is a very bad proxy for determining value. It cannot even be considered a derivative of value. It’s far worse. At a minimum, a derivative security actually derives its underlying value from another asset or group of assets
• PM Valuation is far riskier and worse than a derivative because there are well-documented, glaring flaws in the methodology; that all prior rounds with different economics are suddenly worth the same as the last round. It’s messed up and it’s improper, as the Study indicates.
• In fact, let me let you in on a key piece of information, a key fact: I’ve known about the concept of PM valuation for more than 20 years, during my time as a venture debt lender. The PM valuation was never intended to be used for this purpose (trying to determine a market value for private companies).
• EXPLAIN: In 90% to 95% of all the deals, loans we did for VC-backed tech companies, they typically had to raise an additional round or two of capital before we were paid out on the loan. When they raised a new round, the Loan & Sec. Agr. required full reporting. And, Many times company mgt and investors would tell us the PM valuation after this round was X.
• We knew how it was calculated and always knew this was not the real market value for the company, b/c of all the terms and conditions of prior rounds of capital. It was always considered a rough, back of the envelope way to look at the company as a very rough approximation of perhaps its future potential value – but in no way did it represent its market value.

The idea that index funds, the financial press, and the analytics companies have been trying, for years now, to use this as a representation of value is insane and it’s fraudulent.

Btw, Why would anyone invest in an index fund that can´t provide investors with a true picture of value? Any index fund should be required, and investors should demand, full disclosure of the valuation methodology. One would think disclosing your valuation methodology would be a strength, a positive, to show investors you do have rigor in your analysis and determination of value. Transparency should be an asset. Instead, these so-called index funds use stealth because they don´t want you to know that they don´t really have visibility and the tools normally utilized to actually determine real market value for these private tech firms.

Why the secrecy and black-box approach if the index funds are asking investors to pony-up vast sums of money to get exposure to private tech company deals?

The risks of a private, early-stage technology company are already significantly high enough; and their performance is not proven nor is it disclosed. To gain exposure to this high-risk asset category via an index fund with a completely improper, bogus notion of value is insane.

Stay Far Away from any Index of Unicorns

So, let´s understand what is really going on here. The facts are these regarding any index comprised of so-called Unicorn tech companies. They possess none of the following key pieces of financial statement information necessary and normally used to properly value a firm:

• Firm’s Actual Revenue and its revenue run rate. Thus, no sense of what aggregate monthly and annual revenues are AND, the growth rate of revenue month-over-month; i.e. How fast are revenues growing?
• More importantly, no sense of a firm’s gross margins and net operating margins – Is there a path to profitability anywhere in the future? Is the firm even generating positive or meaningful gross margins? A firm’s gross margins reflect basic survivability?
• Firm’s Performance to Plan or against the monthly Forecast;
• Firm’s monthly cash burn rate; to understand when they run out of cash, in number of months; to ascertain when they need to raise another round of capital from investors

Each of the above financial metrics would normally be used to value a firm and measure its financial health and trajectory. These so-called index funds do not have access to any of this information and therefore operate in a vacuum when it comes to relying on real financial metrics normally used to value a company.

Investors should be informed as to just how flimsy and flawed these valuations are based on the PM Valuation. The Stanford Study conclusively proves there is a serious problem with the PM Valuation methodology. Further, the Study has developed a methodology that works and clearly demonstrates how to calculate a value for these private tech firms.