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ILLUSTRATIONBYGEORGEWYLESOL◼ LAST THING
With Bloomberg OpinionBy Shuli Ren
The Us and Them of
Investing in Unicorns
WeWork’s fall fromgrace seems to
havebeena temporarysetbackinthe
unicornworld.Caseinpoint:Justdays
intothenewyear,a sourcefamiliar
withChina’ssocial-media/e-commerce
startupLittleRedBooktoldBloomberg
News itwould begin a fundraising
roundaimingfora $6billionvaluation,
doublewhatit wasworthafteritslast
round,in2018.
Butdothisandsimilareye-popping
valuationsreflecttherealvalueofthese
startups?Accordingtoa recentstudy
publishedintheJournalofFinancialEconomics, theaver-
ageunicornis priced48%aboveitsfairvalue.Lookingat
135 unicornsintheU.S.,theauthorsfoundvaluationinfla-
tionineverycase,withthedegreeofoverstatementrang-
ingfrom5%to188%.
Doesthatmeanprivateinvestorsareirrationallyover-
paying? Not necessarily. Unicorns these days can go through
as many as seven funding rounds before emerging on pub-
lic markets, and late-stage investors often insist on layers of
protective clauses to blunt their potential losses.
One popular option, for instance, entitles them to
extra shares if a startup’s valuation at its initial public
offering is lower than where they bought in. Take the
case of WeWork parent company We Co. It agreed to give
some private investors more than $500 million in addi-
tional shares if its IPO valuation fell below $10.5 billion;
most of that would have gone to SoftBank Group Corp. Or
consider Square Inc.’s disappointing 2015 IPO. Its Series Einvestors were promised at least $18.56
per share; when Square’s price came
in at less than half that mark, it had to
give them an extra 10.3 million shares.
There are other clauses that work in
late-stage investors’ favor. Those who
bought in most recently can often get
their money back before everyone else
if the company folds or gets bought.
Others get the right to pull out of an IPO
if Wall Street values the unicorn lower
than what Silicon Valley does.
Take the idea to its logical conclu-
sion, and you wind up with an unsettling thought: If a uni-
corn wanted a $47 billion valuation, investors might be
happy to comply so long as they’re given enough protec-
tion against the possibly inevitable downfall.
Considered in that light, the unicorn world has one
thorny moral hazard problem. All this fine print gets set
down out of the public eye. What retail investors see is an
impressive number they don’t realize is propped up by a
bunch of investors with safety clauses. But there’s also a big
caveat for private investors: All these preferred shares con-
vert into common stock as soon as the unicorn goes pub-
lic, which means the investors lose their valuable options.
If we could see the contractual terms unicorns agree
upon with their patrons, no reasonable investor would say
these startups are worth as much as they claim. But, alas,
these are private contracts, leaving the unicorn world as
murky and fluffy as ever. <BW> �Ren is a finance columnist
for Bloomberg Opinion