No, that’s silly. We may agree to the terms, but there are other people involved in a market, and if they don’t think the economics of our deal make sense, the transaction was not a “price discovery” event after all. You can say your lemonade stand is worth $1 quadrillion if you want, but that doesn’t mean Sequoia Capital is going to give you a capital injection based on that valuation.
Anyway, the Wall Street Journal has a new story raising concerns over the valuation tactics of AI companies in Silicon Valley. This isn’t exactly the same as my lemonade stand example, but it’s useful to keep in mind. The Journal’s reporting comes from unnamed people with inside knowledge of these investments.
The pattern outlined is that two or more parties invest in a company at essentially the same time, but at significantly different prices. For example, according to the Journal, a startup called Serval struck a deal with Sequoia late last year that turned Serval into a $400 million company. Then, for unknown reasons, some other parties “days later” offered a funding round that valued Serval at more than $1 billion – a unicorn in sight!
The Journal claims another company called Aaru hit the $1 billion milestone by offering investment “tiers” with different economics. On paper, half of the investors valued the company at $450 million, and the other half valued it at $1 billion. Different terms and God knows what other factors made different valuations feel right in the minds of different investors for various unknown reasons.
The Journal claims that about 20 such deals have taken place in the last six months to a year.
Venture capitalist Chris Douvos of AHOY Capital told the Journal that this practice “absolutely inflates valuations.” According to Douvos’s assessment, this technique is used to “anoint a winner and suck all the air out of the room.”
So imagine that a famous venture capital company called Refreshment Capital is investing in your lemonade stand. You need supplies, so you ask for $500, and they counter that they’re looking to give you $100 for 10% of your company, your lemonade is worth $1,000. But first, Refreshment Capital says you must use their famous name to convince a librarian to invest a mere $20 once Refreshment Capital’s check clears. But the librarian will only get 1% of your company for $20, your lemonade stand will be worth $2,000.
You get $120 for lemons and sugar. The librarian gets a contact from a reputed refreshment capital-funded company. And Refreshment Capital doubles its investment almost immediately.
The question in your mind is, what does the truest price discovery event in this story look like? Librarian’s investment? Investment of refreshment capital? Or maybe none of the above?
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