Accountability, Rights, and Discipline in Early-Stage Companies

This week, we feature two stories and one study, each of which highlights the need to analyze venture transactions in their entirety, rather than focusing solely on price.

Obituary for the “Founder-Friendly” era of Venture Capital Investing

First, Erin Griffith pens an obituary for the “founder-friendly” era of venture capital investing. Eager venture investors were willing to sacrifice traditional “investor-friendly” terms regarding voting rights and board composition in exchange for the opportunity to invest in high-profile start-ups like Uber, Snap, and Blue Apron.  The latest chapter in the ongoing Uber saga is the lawsuit filed against the company by investor Benchmark Capital.  Regardless of the legal merits, the suit does suggest that even superstar entrepreneurs need accountability.

Squaring Venture Capital Valuations with Reality

Second, we ran across an academic paper from Will Gornall and Ilya Strebulaev cautioning that not all unicorns are really unicorns. Entitled “Squaring Venture Capital Valuations with Reality,” the study’s authors re-value a population of unicorn companies assuming that the terms of later fundraising rounds matter.  Start-up companies have traditionally been christened unicorns upon closing a fundraising round at a per-share price that, when applied to all outstanding shares, implies a value in excess of $1 billion.Not all shares are created equal.  Later round shares inevitably have liquidation preferences, return guarantees, ratchets, or other features that common shareholders or investors in earlier rounds do not possess.  Incorporating the unique rights of the last round investors, the authors found that nearly half of supposed unicorns were, in fact, worth less than $1 billion.  The rights negotiated by the late stage investors matter.

Tesla’s $1.8 Billion Debt Offering

Finally, Tesla was in the news for completing a debt offering. Debt investors seem to share the equity market’s enthusiasm for the company, with the offering raising $1.8 billion, compared to initial expectations of $1.5 billion.  Tapping the debt markets signals that the Tesla board believed the marginal cost of debt to be less than the marginal cost of equity.  While some commentators have noted that the terms of the debt offering are not especially favorable to bondholders, it’s still debt and not equity.  Debt has a way of increasing corporate discipline, and it will be interesting to see what if any changes the debt issuance portends for Tesla, which has historically burned through large amounts of cash in the pursuit of large payoffs.

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