- The value in shares of private venture-backed startups can be difficult to determine, because the nominal per-share value often doesn’t reflect preferential terms given to some shareholders — nor the risk that the companies will go out of business or won’t have successful exits.
- The difficulty in evaluating startup shares is a particular problem for employees, many of whom receive much of their compensation in stock or options in their companies.
- Two finance professors recently developed and launched a new tool tool to help startup employees figure out what their stock holdings are worth.
- The tool is available for free and includes data on some of the biggest startups, including DoorDash and Airbnb.
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How much is a share of DoorDash worth? How about that of Airbnb or Stripe?
The answers to those questions are not at all obvious.
In fact, a few years ago, when Ilya Strebulaev, a finance professor at Stanford’s Graduate School of Business, and Will Gornall, one of his students at the time, started looking into how much the shares of such private startups companies are worth, they discovered that even some seemingly sophisticated investors didn’t really know.
Such stakeholders may have better luck now. Last week, Strebulaev and Gornall, now an assistant finance professor at the University of British Columbia’s business school, launched an online calculator that offers an estimated real value for the shares of any of some 130 large venture-backed startups.
“We realized, really, that nobody knows how to value these private, venture-backed companies,” Strebulaev told Business Insider. He continued: “We thought we should do something about it.”
Public companies are easy to value. Private ones, not so much.
It’s fairly easy to know what a public company is worth — you just look up its stock price. That value is determined daily by the interactions of numerous buyers and sellers who factor in the latest news into what they’ll pay for the shares.
Private companies, by definition, don’t have a public market determining their worth. Instead, their valuation is set by the price a limited number of private investors are willing to pay in their funding rounds, which, at most, happen once or twice a year.
Startups often disclose their overall valuations in press releases when they announce these funding rounds. Those headline numbers — and the share prices associated with them — can also be found on services such as PitchBook or Crunchbase, which collect data on startup funding.
But as WeWork and Casper have demonstrated dramatically lately — and Zoom from the opposite point of view — public investors can have starkly different ideas than venture capitalists about the true value of particular startups. However certain those valuation figures may seem when listed in press releases or in databases, they’re often anything but. As WeWork showed when its nominal valuation got slashed from $47 billion to less than $8 billion last year, even the biggest and most mature startups remain risky bets.
What’s more, those often widely touted startup valuation figures frequently overstate what big investors in those companies actually think they’re worth. The shares held by those stakeholders frequently include provisions that help protect them from any downside in their investments. Those provisions can make those investors’ shares worth significantly more than those held held by employees or early investors.
As a result, the share prices that startups employee see on their personal shares and the strike prices they see on their options “may not be informative,” because they don’t reflect the fact that other shares have greater rights, said Gornall.
The provisions that give those rights “can make the share values to be misleading,” he said.
The professors designed the calculator to help employees
Such factors can be a particular problem for tech workers, since many of them receive much of their compensation in shares and options in their companies. Many likely don’t really know what their stock-based compensation is actually worth, because they may not appreciate that there’s a difference between the nominal and actual value of their shares, the researchers said.
“After talking with startup employees, we felt that there were a variety of misperceptions about the value of their options,” Gornall said.
Gornall and Strebulaev constructed their calculator to help tech workers better understand that value. The calculator, which they launched and plan to keep as a free tool, takes a look at how the provisions attached to investors’ shares affect the implied valuation of the company and of the common shares held by employees.
One particular term often can lead to a big difference between the value of the preferred shares held by venture investors and the common stock held by employees — something known as an IPO ratchet, Strebulaev said. That provision allows certain investors to get extra shares in an initial public offering — more shares than they previously held — if the company’s stock doesn’t debut above a set price. The effect can be to dilute or lessen the value of the common shares held by other owners, typically employees.
The “IPO ratchet has an enormous impact on the valuation,” Strebulaev said.
In some cases, the gap in value between a preferred share and a common share can be huge, Gornall and Strebulaev’s research indicates.
Take The Honest Co., actress Jessica Alba’s personal products online store. In June 2018, the company raised money at a share price of $19.60 a share, according to the professor’s calculator. But that was a price for preferred shares. Taking into account the rights accorded to those and other preferred shares, common stock in The Honest Co. was only worth $12.75 a share, or about 35% less, according to the calculator.
“The Honest Co. is the one that stood out as having a big discrepancy” between preferred and common shares, Gornall said.
Stock options are like lottery tickets
But the calculator does more than just take into account such provisions. Gornall and Strebulaev also designed it to help startup workers understand how much of a windfall they’re likely to see from their shares or options if their company were to go public or be acquired. Factoring in both the provisions including in non-common shares and the volatility of markets, among other things, the calculator displays graphically just how likely it is that employees will get a huge windfall from their startup stock — or far less than that.
For many of the companies in the index, even the brightest names, the chance that employees will see big returns from their shares is relatively small, according to the calculator. Even for early employees that have very low strike prices for their options at a company like DoorDash, which recently filed to go public, the chance that they’ll actually be able to exercise those options and see something for them is less than 60%, the calculator suggests.
The calculator displays this by using both a chart showing the expected distribution of possible returns and through using a metaphor of a six-sided die to visualize potential outcomes.
Startup options and shares are kind of like lottery tickets that can be purchased for a $1 each, Gornall said. He and Strebulaev designed the calculator to give startup employees in particular a sense of what those lottery tickets are actually worth and how likely they are to pay off.
“Given that these companies are so high-risk, you sort of have to think through that,” he said. The nominal value of startups and their shares is typically only going to be realized, he added, “in extreme upside scenarios.”
The professors plan to improve the calculator in the future
The calculator does have its shortcomings. It only has data on a small portion of the 400-some-odd unicorns — venture-backed startups with a valuation of at least $1 billion — that now exist and nothing on the much wider universe of venture-backed startups. So, employees that work for a brand-new firm or one that hasn’t yet reached unicorn status won’t be able to use it to figure out how much their options are worth.
Meanwhile, the volatility measure built into the calculator doesn’t necessarily reflect some of what’s been going on in the market lately, Gornall acknowledged. So it doesn’t factor in things such as the big selloff due to the new coronavirus or the shadow cast on the tech IPO market by the failure of WeWork’s offering and the poor performance of many of the unicorns that have gone public in the last year.
“Downturns in the market are not going to be reflected in this,” Gornall said.
But the researchers plan to keep improving the calculator. They’ve gotten funding to maintain and expand it from the Stanford Venture Capital Initiative. They hope to eventually include data from 200 or maybe even 500 companies inside it, Strebulaev said.
They also are working on creating a kind of index of valuations of VC-backed firms, something like the Case Shiller index in the residential real-estate market, Gornall said. Assuming that data is helpful in understanding the value of startup options, they may incorporate it into the calculator also, he said.
Even it’s not 100% accurate or complete, the tool already offers many startup employees a much better way of calculating the value of their stock-based compensation than they had before, the researchers argued.
“I think it’s important to contribute to the society in our small, kind of modest way,” Strebulaev said.
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