Pando

Unicorn sugar crash

By Sarah Lacy , written on May 16, 2015

From The News Desk

It's always interesting to know when a company gets a $1 billion valuation. But, as Pando has written time and time again, a valuation is not the most important term on a term sheet. It is not the ultimate arbiter of a company's health. We've even gone so far as to say it is "arbitrary as fuck." 

Other publications have tried to put this "one metric to rule all metrics" in proportion as well. And yet, many entrepreneurs read these things, nod sagely, and then turn around and optimize for a $1 billion valuation to be part of the club. Entrepreneurs are eternal optimists and so they figure the problems around high valuations are problems for another day... or even another company.

Hoping to break through unicorn fever, long time investor and entrepreneur Heidi Roizen came at the warning from another angle this week: A Tumblr post in which she describes a fictional company that mirrors many very real situations she's seen before. She called it "How to build a unicorn from scratch-- and walk away with nothing." It shows how investors, strategics and entrepreneurs can all make reasonable in-the-moment decisions that can wind up utterly washing out a founding team-- even if the company gets a decent exit. The parable doesn't even include particularly onerous terms like multiple liquidation preferences, but pretty standard terms. (She cribs names from the HBO show, although the situation she describes is much more grounded in reality with far fewer dick jokes.)

From the post:

They float the magic “B” valuation. Richard goes to sleep dreaming of rainbows and unicorns.

Richard fantasizes about being named a member of the Unicorn Club by the press.  His employees calculate the huge paper gains on their options – they will all be instant millionaires – and since no one is more than ¼ vested, they are all highly motivated to stay in spite of long, long work hours.  BTV is thrilled with the 20x markup on Pied Piper, since they are about to hit their LPs up for a new fund.   The original investor, Peter, has achieved legendary status – his $1 million has turned into approximately $200 million on paper.  He’s on the YC VIP sneak preview list, he’s been offered a spot on Shark Tank, and Ashton just called to try to get into his next deal. Sound familiar? Roizen then details a fictional downward spiral. As Sequoia Capital said in its famous RIP Good Times speech: You almost never come out of them once you're in one. Go read the whole thing on her blog if you've raised money or are thinking about it. The incentives all line up on the way up, and then fall apart once the company stumbles. And all companies stumble.

Once you are done, go here and download this easily manipulated waterfall liquidation model, courtesy of CB Insights, to understand why your cap table may not be the North Star you think it is.

Startups always say they know the bulk of companies fail and these things are "experiments," but living the downside can be a whole different situation from the rhetoric. Too often in a zeal to get cash in the bank and focus on work, entrepreneurs sign things and agree to things that they're assured are "standard" that they don't totally understand or feel they can't push back on.

It's worth remembering in the last ten years only 240 venture backed companies have gone public. Just last year, 231 companies raised more than $40 million in growth rounds. A decent chunk of those are gonna live a version of Roizen's story.