modern unicorn

The world is filled with unicorns:


Look at all those tech companies with their “over $1 billion” valuations.

But like the bull with the fused horn buds, I don’t think that these are really as magical as they appear. Instead, when it comes to tech companies, my general feeling is that journalists tend to take a number and multiply it by other numbers and declare “OMG – a unicorn!”

So let me illustrate that with:

The Nitty-Gritty of Financing Rounds

Here’s a hypothetical situation:

  1. I lend you $100 for your start-up business.
  2. You have to repay me $125.
  3. You repay $125 in cash.

This – this is a loan.

Now let me twist the hypothetical situation around:

  1. I lend you $100 for your start-up business.
  2. You have to repay a minimum of $125.
  3. You repay $125, but you do so by issuing me with shares that I can sell in an IPO for $125, with some potential upside if the share price pops.
  4. You tell me that you plan to sell shares in the IPO for a minimum of 25 cents a piece.
  5. So you issue me with 500 shares.
  6. Let’s say that there are 5 million shares in the company.

Is this still a loan? Well, there is talk of shares. And the big difference between the original scenario and the updated one is what would happen if the shares are sold for less than 25 cents in the IPO.

So allow me to twist the scenario further:

  1. I realise that there is an issue with the “25 cents” share price – because no one can guarantee that.
  2. So I say to you: “Look, I’m concerned about these 500 shares. So let’s include a ‘ratchet’ clause, which says that if you issue shares in the IPO at less than 25 cents a share, then you will issue me with more shares immediately prior to the IPO to compensate for the shortfall, and thereby ensure that I can recover my $125.”

Which brings us neatly back to square 1*: this is basically a loan, with some potential extra upside if the share price does well in the IPO. That is:
*Pun intended – I will come back to this.

  1. I have lent you $100.
  2. You have to repay a minimum of $125.
  3. You will repay this with 500 shares in the IPO – and if those 500 shares are not worth $125 in the IPO, then you will ratchet up my shares until I have $125 worth of shares.

Question: is this a valuation of the company though?


its a no from me

The share price can be whatever we want it to be: the shares are simply a settlement mechanism, and they can be adjusted (both in terms of number and price)

But the media at this point would value the company at $1.25 million (5 million shares at the $0.25 per share mentioned in the agreement). Even though this is really just a $100 loan.

Taking this back to Square

So Square was the latest unicorn IPO, and the big drama around it was that the IPO price was cut to $9 per share – ‘valuing’ the company well below the notional $15 per share that was used in the last round of private financing.

Did the last round of private financiers lose money though? Did they take the 40% hit in their investment value?

its still a no from me

Of course not. They ratcheted with their ratchet clauses, and here’s a table from Matt Levine at Bloomberg:

square ipo

Here’s a graph of how things would look with and without that ratchet clause:

all the ratcheting

And what we should notice is:

  1. Early round financiers have really great returns (these guys take on far more equity risk);
  2. Later round financiers are much closer to debt-lenders.
  3. But everyone made their money back.
  4. And everybody ratchets.


So are all the unicorns actually unicorns?

Almost certainly not – because you cannot treat financing round agreements like they are company valuations.

And if you do treat them the same, then you get this kind of satirical madness:

Screen Shot 2015-12-04 at 9.48.48 AM

Read the entire article here at Medium. It’s hilarious – and a shout out to my friend Kosta for sending me the link.

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at Or both.