Startup Valuations and Plain English

Start Up Valuations | Andrew Abramowitz, PLLCWriting his usual daily roundup in Bloomberg View, Matt Levine, a former corporate attorney and investment banker who is perhaps the only person in the world who writes in a laugh-out-loud manner about securities law, raises interesting points on two unrelated topics: startup valuation and plain English writing.

Unlike public companies, which typically have one class of stock and a known market price, Levine notes that VC-backed startups typically have multiple classes of preferred stock with liquidation preferences, among other rights. The existence of these rights means that you can’t figure out the valuation of preferred shares by simply assuming that all preferred shares are converted to common and dividing the total value by the number of shares. The shares receive an additional distribution on liquidation that makes them more valuable. But what makes it more complicated is that the effect of this right is dependent on the outcome of the company’s performance. If the company is sold for a fraction of its previous valuation, the liquidation preference will result in the preferred holders receiving perhaps all of the sale proceeds, with common receiving none. If the company goes public or is sold at a high valuation, the liquidation preference essentially becomes irrelevant. Additionally, as Levine notes, this isn’t just a distinction between preferred and common; each class may have a different liquidation preference and seniority. So, while you may be able to set a value on an entire private company based on usual financial measures, the way the pie is divided up among the classes upon sale or IPO is uncertain.

On Levine’s other topic, he points out that those focused on plain English disclosure get caught up with anachronistic phrases like “Notwithstanding anything to the contrary herein.” He rightly notes that the real issue is that sometimes the topic being discussed is inherently complex – see, for example, my previous paragraph. It’s not just legal/financial topics that are hard to render for a mass audience; certain industries involve complex technology that are hard for lay people to understand. I have a client developing a technology that uses green plants to grow proteins to be used in vaccines and other medicines. That general concept is easy enough to understand, but when the company discloses (as it must) how its technology works and how that differs from competitive methods of producing those proteins, that’s about biochemistry, and most people don’t understand that. This isn’t an issue that will be solved by writing about it in the first person; ultimately, people investing in individual companies that involve obscure technology should be relying on the advice of people who understand it unless they’re experts themselves.