By Jared Carmel
Although Instacart’s “slashed” valuation made headlines earlier this year, investors shouldn’t expect to see valuation cuts like these go away anytime soon. In fact, we are going to see lots of write-downs from late-stage companies.
Instacart is just the beginning, and this trend isn’t a bad thing.
The first thing to understand when looking at these valuations is that a write-down doesn’t change the true value of the company. True value is the price paid between a willing buyer and a willing seller.
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A write-down is simply an acknowledgement, or assertion, that the value has changed. The write-down itself is actually based on a 409(a) valuation. Companies do all they can to “game” the 409(a), because the cheaper the exercise price, the more valuable the option. In fact, most people don’t realize that in almost all cases, the 409(a) is well below the price paid in a round of financing.
So why are write-downs good? Because write-downs help companies attract and retain talent. If companies can’t use cheap stock to pay their employees, they would have to either give them more shares, or pay them cash. Neither one of those is good for shareholders. But beyond that, when companies can issue low-priced stock options to their employees, there is a greater potential for more upside down the road.
Companies have long realized this, and as a result, will do a snap, ad hoc 409(a), in addition to their typical yearly valuation, specifically to take advantage of a temporarily depressed price.
While a company’s forecasted future results are certainly a consideration in determining 409(a) value, the readily identifiable trading multiples of public companies is much more important.
So a company which has no change in its outlook (or even a positive change), can have a reduced value just based on what the public market is doing. In Instacart’s case, the performance of companies like DoorDash and Uber enable the company to take the write down.
Many companies will viscerally avoid these markdowns whether it is in their 409(a) valuations or when it comes to setting terms for their next financing. Venture funds, too, may hate it, because, while it may not affect their economics, it affects their marked positions, and the returns they use to market their next funds when evaluating fund investments.
But investors in the secondary market can take advantage of new marketplace realities to invest in even more companies at even better prices, even if companies don’t unilaterally lower their values. And companies can leverage these write-downs to continue growing their businesses.
Jared Carmel is a managing partner and co-founder at Manhattan Venture Partners (MVP), a venture fund and research-driven merchant bank focused on the secondary market for late-stage, venture backed, tech companies.
Illustration: Dom Guzman
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