We develop a valuation model for venture capital--backed companies and apply it to 135 US unicorns, that is, private companies with reported valuations above $1 billion. We value unicorns using financial terms from legal filings and find that reported unicorn post--money valuations average 48% above fair value, with 14 being more than 100% above. Reported valuations assume that 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 initial public offering (IPO) return guarantees (15%), vetoes over down-IPOs (24%), or seniority to all other investors (30%). Common shares lack all such protections and are 56% overvalued. After adjusting for these valuation-inflating terms, almost one-half (65 out of 135) of unicorns lose their unicorn status.
We survey 885 institutional venture capitalists (VCs) at 681 firms to learn how they make decisions across eight areas: deal sourcing; investment decisions; valuation; deal structure; post-investment value-added; exits; internal organization of firms; and relationships with limited partners. In selecting investments, VCs see the management team as more important than business related characteristics such as product or technology. They also attribute more of the likelihood of ultimate investment success or failure to the team than to the business. While deal sourcing, deal selection, and post-investment value-added all contribute to value creation, the VCs rate deal selection as the most important of the three. We also explore (and find) differences in practices across industry, stage, geography and past success. We compare our results to those for CFOs (Graham and Harvey 2001) and private equity investors (Gompers, Kaplan and Mukharlyamov forthcoming).
We develop a model of the joint capital structure decisions of banks and their borrowers. Strikingly high bank leverage emerges naturally from the interplay between two sets of forces. First, seniority and diversification reduce bank asset volatility by an order of magnitude relative to that of their borrowers. Second, previously unstudied supply chain effects mean that highly levered financial intermediaries can offer the lowest interest rates. Low asset volatility enables banks to take on high leverage safely; supply chain effects compel them to do so. Firms with low leverage also arise naturally, as borrowers internalize the systematic risk costs they impose on their lenders. Because risk assessment techniques from the Basel framework underlie our model, we can quantify the impact capital regulation and other government interventions have on leverage and fragility. Deposit insurance and the expectation of government bailouts increase not only bank risk taking, but also borrower risk taking. Capital regulation lowers bank leverage but can lead to compensating increases in the leverage of borrowers, which can paradoxically lead to riskier banks. Doubling current capital requirements would reduce the default risk of banks exposed to moral hazard by up to 90%, with only a small increase in bank interest rates.
Locally-capped products are a popular but poorly understood type of structured
financial product. These contracts combine a guaranteed payoff with a bonus based
on the capped periodic returns of a reference portfolio. We show that in the USA
these products often contain unreasonably optimistic hypothetical scenarios in their
prospectuses,and conjecture that these unrealistic scenarios may contribute to their
popularity with uninformed investors. We also explain why locally-capped products
perform badly in turbulent markets and confirm this with evidence from the 2008
We study gender and race in high-impact entrepreneurship within a tightly controlled random
field experiment. We sent out 80,000 pitch emails introducing promising but fictitious start-ups to
28,000 venture capitalists and business angels. Each email was sent by a fictitious entrepreneur
with a randomly selected gender (male or female) and race (Asian or White). Female entrepreneurs
received an 8% higher rate of interested replies than male entrepreneurs pitching identical projects.
Asian entrepreneurs received a 6% higher rate than White entrepreneurs. Our results are not
consistent with discrimination against females or Asians at the initial contact stage of the investment
This paper uses bank fragility to explain why bank loans are senior in firm capital structure. High leverage makes banks more vulnerable to financial distress than the typical bond investor, and thus makes banks willing to pay for seniority. Bank seniority emerges even when banks need skin in the game, as bank effort has more impact on a large senior loan than on a smaller junior claim with the same systematic risk. Adding deposit insurance or bailouts adds a subsidy to tail risk, which makes large senior claims even more attractive to banks. Empirically, this model explains why procyclical firms avoid bank loans and provides a host of debt structure predictions.
Over the past 30 years, venture capital has become a dominant force in the financing of innovative American companies. From Google to Intel to FedEx, companies supported by venture capital have profoundly changed the U.S. economy. Despite the young age of the venture capital industry, public companies with venture capital backing employ four million people and account for one-fifth of the market capitalization and 44% of the research and development spending of U.S. public companies. From research and development to employment to simple revenue, the companies funded by venture capital are a major part of the U.S. economy.