United States: The Terms Behind The Unicorn Valuations

Last Updated: May 8 2015

Article by Barry Kramer, Michael Patrick and Nicole Harper, Harper Power Law Firm

BACKGROUND

There has been much discussion about the high valuations of venture backed companies, and especially the "unicorns", companies with a valuation of a billion dollars or higher. However, as the investors in these companies generally receive preferred stock, rather than the common stock that is issued in IPOs and held by public company investors, unicorn valuations are not directly comparable to public company valuations.

To better understand unicorn valuations we analyzed the terms of 37 US based venture backed companies that raised money at valuations of $1 billion or more in the 12 month period ending March 31, 2015.

The average valuation of the companies we analyzed was $4.4 billion, the median valuation was $1.6 billion, the average percentage increase per share from the prior financing round was 180%, and the median percentage increase per share from the prior financing round was 100%. Of these financings, approximately 25% were led by traditional VC investors and approximately 75% were led by investors who were not traditional VCs (e.g., mutual funds, hedge funds, sovereign wealth or corporate investors).

OVERVIEW OF RESULTS

The highlights of our results are as follows:

  • Investors received terms that provided a fair amount of downside protection for their investment, especially in the event of an acquisition, but relatively few upside benefits.
  • These terms could result in a divergence in interest between early and late stage investors at the time of a liquidity event.
  • A significant percentage of the highest valuation unicorns had dual class common stock which provided founders/management and in some cases other shareholders with super voting rights.
  • Attaining a unicorn valuation appears to be a goal of promising companies raising money, as 35% of the companies we analyzed had valuations in the $1-1.1 billion dollar range, indicating that the companies may have negotiated specifically to attain the unicorn level.

SURVEY RESULTS

Downside Protections

There are various different preferred stock terms that investors can use to protect their investment in the event the company's value declines. These terms include:

  • liquidation preferences (which require that an investor receives its investment back prior to common investors receiving any proceeds, and if the investor has a senior liquidation preference, it receives its investment back not only before common investors, but also before other series of preferred stock);
  • IPO conversion provisions (which provide, among other things, that an investor's preferred stock will only convert to common stock in an IPO, if the IPO is at a certain valuation, usually at least what the investor paid, or providing that if the IPO is at less than a certain valuation, the investor gets additional shares). Note that the conversion of outstanding preferred stock into common stock is basically a requirement to go public; and
  • anti-dilution adjustments (which retroactively reduce the price of the stock an investor purchased if the company raises funds in a non-IPO future financing at a lower price).

Our analysis showed that the forgoing terms were used in the following percentage of unicorn financings:

Acquisition Protection Terms
Liquidation protection over common stock – 100%
Senior liquidation protection over other series of preferred stock - 19%

IPO Protection Terms
Minimum IPO price must be no less than unicorn round investment price – 16%
Payment of additional shares if IPO price below unicorn round investment price – 14%

Future Financing Protection Terms
Weighted average – 100%
Ratchet – 0%

*** Analysis: Investors in unicorn financings have significantly more downside protection than public company common stock investors. These protections are especially strong in the event of an acquisition. For example, CB Insights reported that the 10 highest valued unicorns had an aggregate valuation of $122 billion and an aggregate invested capital of $12 billion. Since 100% of the unicorn financings had a liquidation preference, valuations of these companies could fall on average by 90% before the unicorn investors would suffer a loss of their investment, and they could withstand an even greater decline if they had a senior liquidation preference over other series of preferred stock.

IPO protections for investors were less strong. This is probably in part because investors assume that an IPO transaction in and of itself is an indication that a company is doing well, although a unicorn company could be doing well but still go public at a price per share less than the price paid by the unicorn investor. Approximately 30% of unicorn investors had significant protection against a down round IPO.

Future financing protection was present in the form of weighted average anti dilution protection in all rounds. This provides some, but very limited, protection.

Upside Benefits

There are also various terms that unicorn investors can use to enhance their upside potential in a company. These provisions include:

  • cumulative dividends
  • liquidation participation (which provides that after an investor receives its money back in an acquisition, the investor then gets to participate with common shareholders in receiving the remaining proceeds).
  • multiple liquidation preference (which provides that an investor gets more than its initial investment back before common shareholders (or possibly other preferred shareholders) receive any funds in a liquidation).
  • IPO auto conversion threshold that is above the price paid by the investor, which assures the unicorn investor a profit on an IPO

Our analysis showed that these terms were infrequently used, as follows:

Cumulative dividends – 0%
Participating preferred – 5%
Multiple liquidation preference – 3%
IPO auto convert above per share price paid by investor – 11%

***Analysis: A result of the significant downside protections and relatively limited upside benefits provided to unicorn investors is that there could be a large range of valuations at which a unicorn could exit, especially by acquisition, in which the unicorn investor would be indifferent because it will not affect its return. For example, if an investor invested in a unicorn at a post money valuation of $10 billion and the company had $1 billion of total investment after such investment, and the investor had the typical non-participating liquidation preference, then the investor would be indifferent if the company was sold at any valuation between $1 billion and $10 billion. This could result in the investor having different strategic interests than investors who have invested at lower valuations. For example the founders and early investors might welcome an opportunity to sell the company at $8 billion, but in that case the unicorn investor might prefer that the company not sell, but rather try to build more value above $10 billion, so that the unicorn investor makes a gain on its investment.

This difference of interests is not unusual in venture capital, but the range of values at which late stage investors are indifferent is much larger than in the past when overall valuations were lower. One way to address this situation is to let founders/management/early investors sell some shares in a secondary transaction to reduce their interest in an early exit. But in most cases, if there is a difference of interest on when to sell the company, the founders/management and early investors will have the voting power to prevail.

Super Voting Stock

22% of unicorn companies had a dual class common stock structure, which provided for one class of common stock to have significantly more voting power than the other class of common stock.

Of these companies, 37.5% provided super voting common only to founders and/or management, 25% provided such common stock to founders/management and early stage investors, and 37.5% provided such common stock to all pre IPO investors.

The companies that had dual class common stock structures were concentrated at higher unicorn valuations, with 70% of the top 10 highest valuations having such structure.

*** Analysis: The concentration of dual class super voting common stock provisions in the highest valuation unicorn financings likely reflects the expectation that these companies are most likely to go public, that insiders have a desire to maintain significant voting control after the IPO, and that these companies have the negotiating leverage to obtain these provisions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
7 Nov 2018, Other, California, United States

Six years after the AIA, and patent professionals are no closer to resolving the legal uncertainty it created and its disruption to their business.

7 Nov 2018, Speaking Engagement, California, United States

Fenwick & West and Berkeley Center for Law and Technology invite you to a half-day conference to offer insights on the current legal sandbox in gaming an​d esports and the gambling in these industries.

8 Nov 2018, Other, Seattle, United States

Fenwick Counsel Robert Brownstone is lead chair​ in this highly interactive colloquium will provide a deep understanding and practical advice regarding major e-discovery challenges facing organizations today.

Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions