How You Can Beat the Unicorn Multi-Billion Dollar Valuation Game

0 | By Shah Gilani

If you’ve ever wondered what’s really driving private companies when they don’t report their financials publicly but instead get the word out when their “valuation” reaches a billion dollars, or many times that, well then I’m going to tell you.

Usually, what’s driving the company is “The Valuation Game”.

Sometimes the Game’s real meaning that the company’s valuation is justified.

But, not quite half the time, the Game is so unrealistic that companies’ valuation numbers should be classified as fantasy, not fact.

Here’s how The Valuation Game is played, how investors are getting burned, and how to play to win…

How Overvalued Unicorns Lose their Magical Status and Your Investments

Last week I explained that private company valuation methods include multiplying the per share cost of the last round of financing an investor or group of investors pays for their shares, times all the shares of the company, accounting for as many shares as possible (essentially fully-diluted, outstanding shares), to come up with the company’s equity valuation.

That’s how successive rounds of equity funding in a private company elevates the valuation of the company without regard to its profitability or the company’s different classes of securities.

But those different classes of shares, which are made attractive to later stage investors, have different bells and whistles, different cash flow and liquidation or IPO valuation rights.

All together, they make the simple formula of multiplying the last-in investors per share price times all other shares outstanding, a fantasy valuation.

A National Bureau of Economic Research working paper titled SQUARING VENTURE CAPITAL VALUATIONS WITH REALITY found that when they “valued unicorns using financial terms from legal filings,” unicorns’ post-money valuation averaged 50% above fair value.

The paper described the present problem with how companies and their investors value themselves, its methodology, and its actual findings this way, “Reported valuations assume all shares are as valuable as the most recently issued preferred shares.”

“We calculate values for each share class, which yields lower valuations because most unicorns gave recent investors major protections such as IPO return guarantees (14%), vetoes over down-IPOs (24%), or seniority to all other investors (32%). Common shares lack all such protections and are 58% overvalued.”

Alarmingly, the paper stated, “After adjusting for these valuation-inflating terms, almost one-half (65 out of 135) of unicorns lose their unicorn status.”

Even more alarmingly, not only did 48% of the unicorns lose their hyped-up billion-dollar status, 15 of the 165 were valued at more than 100% above their realistic valuations, and the ten most overvalued companies were on average overvalued by more than 170%.

The Game’s played for the benefit of early and later-stage investors. Last-in investors, who help jack-up the whole valuation of a company, usually make out like bandits too, though not always.

Last-in investors are often red meat for upcoming IPOs. By paying up for their shares, which have their own perks, last-in investors who know the company’s gearing up for an IPO, elevate the public’s perception of the company’s value before the company announces its going to sell its shares to the public.

Boosting a company’s valuation, often well into the tens of billions of dollars’ arena before an IPO not only helps show a positive up-trending valuation trajectory, it makes the company look more attractive if the last-in investors are well known players like a Fidelity Investments or a T. Rowe Price. And often lately, they are.

How to Calculate the Valuation Game in Your Financial Favor

Of course, the public doesn’t understand The Game and are often lured into buying shares in an IPO that they assume must be a good investment if the valuation of the company’s been climbing to the sky. Why wouldn’t it keep climbing as a public company?

Well, maybe because going public is just a way for already sitting pretty early, later-stage, and last-in investors to cash out.

It’s time for investors in IPOs to understand what part late-stage and last-in investors play in jacking up company valuations to insane levels. It’s time they understand what The Valuation Game is and how to play it.

For the most part, unless the company going public is making profits, or if they’ve got a fundamentally unique business model that’s a world-class “disrupter,” like Google, like Amazon, like Facebook, like Impossible Foods, and they haven’t waited too long to go public, because they’ve been jacking up their valuation metrics for years, don’t be the insiders fall guy.

The average time a venture capital backed startup that had multiple add-on investment rounds took to go public was 8 years. Today, companies wait on average 11 years. That’s because they can attract more later-stage investors more quickly these days and pump up their valuation numbers more easily.

That’s possible because of how much money has been made by investors in startups and by public investors who bought into the likes Google and Facebook.

An ever-growing pool of big-time investors now want to get into private companies and are willing to be later-stage and last-in investors, because they know how the Game is played.

But it’s changing now that the rules of the Game are being stripped naked for mom and pop investors.

Look at Uber and Lyft. They played the Game and lost. And investors in their public stock are losers too. That’s because they don’t make money and only looked good on account of having insane valuations, based on you know what now.

The good news is now you don’t have to get beaten up playing the Game.

Now, you know how to look at a company’s valuation before it goes public and after its IPO.

Now you know you can make a lot of money shorting some of the fake value companies after they come to market in a cloud of fantasy expectations.

And, if you don’t know, keep reading here. I’ll be calling them as I see them and telling you which stocks to short, like I’ve already been doing with my subscribers to my 10X Trader.

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