Tech Startup and mutual funds – Just how much is a unicorn worth anyway?
According to knowledgeable sources that spoke to the Wall Street Journal, the SEC has begun to look more closely at whether U.S. mutual funds are using proper methods to accurately value shares of private technology startups.
The sources note the SEC has recently been inquiring at large fund firms regarding how they value startups and how their process reliably ensures an accurate estimate.
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Wide variation in tech startup valuations
It is standard policy for the SEC to undertake checkups of mutual funds where they examine various metrics such as the proportion of funds’ holdings that are in hard-to-sell securities, include shares of private firms. Obviously, the amount of hard-to-sell shares is one key indicator for how easily a mutual-fund investor would be able to get his money back from a fund on short notice. According to the WSJ sources, SEC examiners have begun to focus in these regular reviews on possible shortcomings in the methodology for tech startup valuations.
The shares of private startups are “not traded on an exchange, so a market quote is not readily available,” explains Jay Baris, a partner and chair of the law firm Morrison & Foerster’s investment-management practice. “The question is, how do you put a fair value on it when you’re looking at squishy data?”
As noted by ValueWalk, large asset managers have been stocking up on and driving up the share price of private tech “unicorns” over the past several years. That is why popular startups such as Uber Technologies, Dropbox and Airbnb (and 41 others) are now valued at above $1 billion. Of note, five of the biggest fund firms participated in funding rounds totaling $8.3 billion through September 30th of this year, up from a mere $1 billion for all of 2011, based on data from research firm CB Insights.
That said, it is clear mutual-fund firms are struggling to accurately value startups and are often reporting quite different prices for the same company.
According to WSJ research into data provided by Morningstar on startups worth at least $1 billion, there were 12 times over the past two years in which the same private firm was valued notably differently by more than one mutual fund on the same date.
In the second quarter, for example, Fidelity claimed ride-sharing service Uber was worth $33.32 a share, Hartford Financial Services Group said it was $35.67 a share and BlackRock said the firm was worth $40.02 a share.
Mutual funds use different methods and procedures to value startups. Some funds place a price on a startup relative to its most-recent funding valuation, and others determine the price relative to similar public companies or other market trends.
In most cases, fund firms will not disclose their methods for valuing startup companies, claiming they don’t want their valuation procedures known by the competition.
Hartford Growth Opportunities Fund
The $1.4 billion Hartford Growth Opportunities Fund reports that as of the end of the second quarter, it was holding preferred shares of 10 privately-held companies below its original cost bases. The firms included daily fantasy sports site DraftKings, which The Hartford marked down 10% several months before its regulatory problems this fall. Pinterest shares that The Hartford acquired back in March were also marked down 10% below cost. The firm also reported a 7.12% reduction in the share price of cybersecurity company Lookout relative to the purchase price one year prior.
The Hartford’s investments in tech startup Docusign include five different classes of preferred stock. Four of the five classes (bought in the first quarter) have increased in value, but the fifth (purchased two months later) is discounted by 10% from the original purchase price. The firm’s Docusign investment as a whole is up 23.4%, but that’s peeny ante compared to the 130% increase in value for the Uber shares it bought in mid-2014.
How big is the unicorn universe? ZeroHedge points out that the combined “valuation” of total US unicorns is $486 billion. Their combined profit?