PitchBook once posed the question: Private vs. public market investors – Who’s reaping the gains from the rise of unicorns?
I have previously written about the flaw in the analysis about Unicorns and feel this article does the same. The valuation last achieved in a unique class of preferred stock is (mistakenly) applied to the entire cap table of the company in order to assume it’s worth over $1 billion.
This is untrue because the earlier investors (particularly founders and common stock holders) are not promised minimum returns on their investment/ownership or an adjustment in their conversion price if a liquidation event (including an IPO) does not achieve pricing at a minimum threshold.
I would argue part of the reason for the decline of IPO’s in the market is this:
The valuation provided by the market to the single class of common stock (after conversion of the various preferred stocks), in most cases, cannot hit the marginal Unicorn valuation of the last investment in the most recent preferred stock, thus giving the appearance that the Unicorn lost value.
In fact, the last investor likely made exactly the minimum return they expected while the earliest investors took the hit for the apparent decline in valuation.
What would be far more interesting to me is an analysis of the returns the earliest investors receive after all the financial protections are applied to the multiple layers of preferred stocks.
As we have seen in the liquidation of failed Unicorns, the common stock and option holders may come out with little or nothing while the preferred stock enjoys their liquidation preference to return all or part of their investment first. The IPO is the great equalizer bringing all the classes of shares into one through what is usually a complex conversion calculation.
