EquityZen Knowledge Center

EquityZen has curated this list of quality resources for secondary investors, shareholders and company representatives.
Have additional questions? We'd love to hear from you.

Unicorns, Donkeys, and Late Stage Valuations - Are You Managing Your Portfolio Well? (Part 2)

UnicornLate Stage ValuationPortfolio ManagementPortfolio BalancingAngel InvestingStartup Valuation
...show more tags

Atish Davda   December 17, 2015

Remember Bob and Susan who walked into a bar? This article is part two of a two-part series on investing in growth technology given concerns over late stage valuations. Click here for part one.

Bob and Susan are still at the bar…

Private Secondary Market
Bob: “Aren’t private investments illiquid? How can you rebalance them?”
Susan: “Liquidity is a sliding scale. Google stock is liquid. Your late stage investment is less liquid. Your broken VCR is illiquid.”

Less liquid is not the same as illiquid. Many private market investors may not realize there are active secondary markets that could help them move into and out of investments with the company’s blessing. Secondary markets are a venue where investors can sell some of their investment, just like they can with their Facebook stock through Schwab, with the added step of getting the underlying company’s permission. Of course, as Susan points out, liquidity is a sliding scale, with private investments being less liquid than the public ones.

Just as with public markets, if you have seen investment appreciation that meets your target IRR, it might make sense to sell a portion of holdings in a given name to lock in a target return5. Rather than continuing to leave the investment capital and gains at risk, investors might consider re-deploying it into a different company. Here at EquityZen, we see savvy shareholders (employees and early investors) diversify themselves by selling some of their holdings and deploying the cash into other investments6.


Overthinking It
Bob: “Why isn’t everyone doing this?”
Susan: “More do it than you think. Private markets have only recently begun to mature rapidly. Don’t overthink it.”

There is currently, an irrational avoidance of portfolio rebalancing, primarily driven by two factors. First, as discussed above, many new investors are simply not aware of avenues to rebalance. Secondly, there is a misconception that selling private stock is equivalent to loss of confidence in the investment. That argument is like assuming the only reason Bob would sell his AMZN shares is because he believes the investment will tank. Couldn’t Bob have also hit his target return and wanted to sell some of his holdings? Couldn’t Bob simply see a better investment opportunity? Couldn’t Bob simply need cash to buy a new house?

As traditional modern portfolio management theory suggests, diversification is crucial. Benefits from diversification can be derived by diversifying across sub-sectors (e.g. hardware, Internet of things, cloud, etc.) as well as across stages of the company (pre-seed and seed, Series A-C, growth equity, etc.).

Portfolio Management
Private market investments are highly risky and therefore deserve a small, but non-zero portion of the total portfolio’s allocation. It is easy to see there is a big difference between a company that has been in existence for 3 months, one that has raised $30M in VC financing, and one that generates $30M of annual revenue. There is a place in Bob’s portfolio for each of them. It is a little harder to see that if there is uncertainty about the market cycle, the relatively safer investment is in the company that generates $30M in revenue7. Given uncertainty in the market, should Bob keep investing in 3 month-old businesses, or take some of that capital and put in in a business generating tens of millions in revenue?

Since venture capital industry have had a consistent shortlist of top-decile performing money-managers, tracking portfolios of these proven VCs is another strategy that private investors find fruitful. As discussed in part one of this series, getting access to those investments (that is, getting into the exclusive country club) used to be nearly impossible, but can now be performed online. Simply Google search “invest in [your desired company]” to see what options you have available to invest on the secondary market.

Warren Buffett famously said “if you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.” No one is suggesting Bob attempt to trade private investments every six months or even every couple of years. But, from time to time, even Warren Buffett is rumored to have rebalanced his portfolio and re-invest.


This article is part two of a two-part series on investing in growth technology given concerns over late stage valuations. Click here for part one.

Disclaimer: This article does not a) constitute investment, financial, or tax advice, b) intend to purport an offer to engage into a securities or similar transaction, nor c) reflect the views of EquityZen. It represents simply my personal opinion.

3: Since these high reward investments, obviously come with high risks, only accredited investors are qualified to invest. Take a qualification test here to see whether you qualify as an accredited investor
Read more...

Unicorns, Donkeys, and Late Stage Valuations - Are You Managing Your Portfolio Well? (Part 1)

UnicornLate Stage ValuationPortfolio ManagementPortfolio BalancingAngel InvestingStartup Valuation
...show more tags

Atish Davda   December 03, 2015

Bob and Susan walk into a bar…

Growth Tech and Increasing Private Market Depth
Bob: “Fidelity marked down Snapchat’s valuation. I’m not sure how to invest in tech right now. Clearly, the bubble is bursting, the good times are over.”
Susan: “Whoa! Slow down. Take a deep breath. Let’s talk through this.”
Think About it 
If you follow the growth technology sector, it is understandable if you share Bob’s concerns. But, as his savvy friend Susan points out, remember to take a breath and make a well-reasoned decision that is right for you.

With technology companies staying private longer before their IPO, a lot of value previously created in public markets has shifted upstream into the private markets1. This structural shift in value creation has led to many private tech companies staying private longer in order to meet the higher bar set by public market investors2. Growth stage tech firms often operate at a loss in order to sustain those eye-popping levels of growth. Companies sustain these losses by raising capital from private market investors, who want to buy low (today) and sell high (years later).


The private market used to be like an exclusive country club, where only big-ticket investors were allowed entry. However, since the most recent wave of private secondary transactions starting in 2013 led by firms like EquityZen (marketplace for private investments – see disclaimer below), accredited investors as defined by the SEC, like Bob and Susan, can now play at the club3.

After years of speculation, the private market is showing its first signs of deceleration in the rise of private company valuations4. So, after years of steady paper gains, Bob and Susan’s investments are showing impacts of a typical market cycle – the rise and fall of asset values in line with macro-economic events.

The First Test
Bob: “But, Square IPO’d below the last round! Isn’t that the swan song for the industry?”
Susan: “Have you ever attended a wedding without a date?”
Bob: “Yes”
Susan: “Does that mean you will go to all weddings, parties, and dinners without one?”

While Bob and other early stage investors may recognize private investing as an asset class has high-risks and high-rewards, they may not be aware of hedging strategies they could implement. It is time to think about their private investments as part of a rapidly maturing industry, with greater options. How they respond to the first real test in the current market cycle will determine whether they feel welcome back at the country club.

Since investors new to the private market frequently consider “angel investing” to be synonymous with “private market investing,” a distinction highlighted in this Inc.com post, they assume traditional VC power law returns for their entire private market portfolio. That is, they spray investments into a lot of companies and pray some of them produce outsized returns.

The spray-and-pray approach leads investors to focus on maximizing-ROI on every investment. While the strategy may work for early stage investments, it is near-sighted if applied to the entire private market allocation of your portfolio. In fact, a better portfolio construction methodology within growth stage companies is to optimize for IRR rather than ROI. Put another way, it makes sense to look at the private market investments, which might include growth stage (as opposed to early-stage) technology firms, as a portfolio you should consider rebalancing.


This article is part one of a two-part series on investing in growth technology given concerns over late stage valuations. Click here to read part two, which covers common portfolio construction strategies Bob can employ…

Disclaimer: This article does not a) constitute investment, financial or tax advice, b) intend to purport an offer to engage into a securities or similar transaction, nor c) reflect the views of EquityZen. It represents simply my personal opinion.

3: Since these high reward investments, obviously come with high risks, only accredited investors are qualified to invest. Take a qualification test here to see whether you qualify as an accredited investor
Read more...

Square's S-1: Of Ratchets and Unicorn Valuations

UnicornSquareIPOInvestorRatchet
...show more tags

Shriram Bhashyam   November 11, 2015

I recently wrote an article for TechCrunch on Square's IPO filing, a (not so little) investment protection known as a ratchet, and larger implications for how to think about Unicorn valuations. We often read about tech companies raising increasingly larger rounds at increasingly lofty valuations. Square's IPO filing, which is publicly available, gives us a peek into the details around private fundraises and the protections VCs get in these deals.

My article is excerpted below:

Over the last 18 months, those of us following the venture and startup space have gone on a rollercoaster ride of mega rounds, Unicorns, sky-high valuations, and bubble fears. Look beyond the hyperbolic headlines and you’ll see that there is more than meets the eye to that shiny new Unicorn valuation. Square’s recent IPO registration statement provides an opportunity to peel the onion on Unicorn valuations (i.e., valuations of $1 billion or greater).

Square's Ratchet

A little more than a year ago, Square raised a $150 million Series E round at a reported $6 billion valuation. The round was led by the Government of Singapore Investment Corporation, with participation from Rizvi Traverse and Goldman Sachs. What we didn’t know then, that we know now, thanks to the S-1 filing, is that the Series E investors had an IPO protection in place known as a ratchet. A ratchet, in this context, provides that if the IPO price does not meet a certain level, say at least the price paid by the investor in the private round or some baked in rate of return above that price, the IPO conversion of those shares to common shares is adjusted such that an additional number of shares are issued to investors which would meet the predetermined level.

I know--that wasn’t easy to follow. But Square’s ratchet will bring the abstract to reality. A quick aside on venture investments. Venture investors are typically issued preferred stock that converts to common shares, based on a given formula, in the event of an IPO. From Square’s S-1, we know that its Series E investors paid $15.46 per share for Series E Preferred Stock. The ratchet in Square’s Series E provides that if the IPO price is less than $18.56 per share, the IPO conversion formula is adjusted such that the Series E investors would receive a number of common shares equivalent to a number if the IPO price had been $18.56. What does this mean? Square’s Series E investors were guaranteed a 20% return in an IPO. On November 6, 2015, Square announced that it expects to price its IPO between $11 and $13 per share. If the IPO were to price in the midpoint of the range ($12 per share), the Series E investors would be issued approximately an additional 5.3 million shares—or $63.6 million of value—under the ratchet in order to achieve the guaranteed return.

Zooming Out

Square is not alone in providing its investors with protective provisions like a ratchet. Box had a similar ratchet in place. It’s increasingly common in mega rounds to build in protections such as IPO ratchets. It’s a sort of win/win for companies and investors. Companies get their shiny Unicorn valuation (which helps with recruiting, in addition to being the vanity metric du jour), and investors get some downside protections, which can even guarantee a minimum return, as in Square’s case. In fact, the law firm Fenwick & West LLP studied venture-backed companies that raised at Unicorn valuations in the twelve months trailing March 31, 2015. That study found that 30% of venture-backed companies that raised capital at Unicorn valuations provided IPO protections in the form of a ratchet.

There are other protective provisions being given by companies, which indicate that Unicorn valuations come with plenty of fine print. In addition to IPO protections, like the ratchet, late stage investors bestowing Unicorn valuations are also receiving acquisition protections. While the 1X liquidation preference is standard, the Fenwick & West study reveals that 19% of financings analyzed included senior liquidation preferences for the investors in the latest round over other series of preferred stock (in simpler terms: last money in, first money out).  Additionally, issuance of participating preferred stock is on the rise, having been issued in 5% of deals in the Fenwick & West study. Participation rights afford its holder a claim to not only the liquidation preference in an acquisition, but also a pro rata share (on an as-converted basis) of proceeds due to common holders. This “double-dip” was common in the following the dot-com bubble, but had disappeared in the recent bull-run in VC. These elaborate provisions give investors in Unicorn financings (i.e., the Big Boys) significantly more downside protection than public company common stock investors.

Rethinking Valuations

The salient point here is that Unicorn valuations often come with asterisks. One may argue that following its Series E round, Square was actually not worth $6 billion (prominent VCs have recently debated this point on Twitter)...

Continue reading on TechCrunch.

Read more...
Have questions?