Unicorns are not real: latest US tech “scam”/ Can unicorns be exited?

In Financial competency on 21/07/2015 at 2:43 pm

PROTECTIONS FOR INVESTORS INFLATE START-UP VALUATIONS Don’t believe all the hype over the “unicorns,” or start-up technology companies valued at more than $1 billion, Randall Smith writes in DealBook, pointing to the late-stage financing terms that inflate a company’s valuation before any initial public offerings of stock – often with little or no disclosure of those terms. Venture investors say that these terms include extra protections, like a discount to the price of any eventual initial offering, a minimum return on investment or extra shares if the company later raises money at a lower valuation. Early stage investors warn that these terms can jeopardize a company’s financial stability, diluting the value of their original stakes and worsening a company’s prospects in a downturn, but the protections appeal to company founders because they provide new cash at the highest nominal valuation, reducing dilution if all goes well.

The protections can push up a unicorn’s valuation 10 percent to 25 percent, said Rick Kline, a lawyer at Goodwin Procter whose firm does legal work on start-up and initial offering financings. He said the phenomenon has been part of a general “frothiness” in late-stage valuations. Neeraj Agrawal, a general partner at Battery Ventures, said such structures work for companies when, “like ‘The Lego Movie’ theme song, everything is awesome.” But, he added, “things won’t always be awesome, and when they aren’t, a company can blow up over this issue.”

THE CASE AGAINST A TECH BUBBLE Last month, three partners at Andreessen Horowitz – Morgan Bender, Benedict Evans and Scott Kupor – made the case to the firm’s limited partners for why today’s tech boom is different from that of the dot-com era. It’s not too surprising that a major venture capital firm is arguing that Silicon Valley is not in a bubble, Steven Davidoff Solomon writes in the Deal Professor column. But he says that the presentation, which was released to the public, is worth a look, “not just for the debate over whether a bubble exists but also because it leads indirectly to the fate of the unicorns and the eventual fallout.”

The partners cite plenty of data to back up their arguments. E-commerce has a lot of growth potential in the United States, making up only 6 percent of retail revenue, and technology funding as a percentage of gross domestic product is only 2.6 percent, compared with 10.8 percent in 1999. Another key difference is the unicorn factor, the start-ups with a valuation of at least $1 billion. Gains that used to go to the public through stock offerings are now going to private investors, the partners contended, citing the example of Facebook. When Facebook went public with a valuation of more than $100 billion, all of its gains went to private investors.

However, Professor Solomon writes, the Andreessen Horowitz presentation inadvertently highlights the problem of the unicorns: No exit.“Competition among venture capitalists to get in on technology start-ups is driving up prices exponentially. But that pricing is justified only if there is an exit. And as Dan Primack noted recently in Fortune, there isn’t one for unicorns.” The venture partners may be right that private markets have pushed out the public ones, but Professor Solomon contends that this shift does not justify the ever-increasing valuations or identify potential buyers of these unicorns. “Perhaps most important, it is silent on how to salvage a unicorn investment when it sours,” he writes.

NYT Dealbook

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