Welcome to the varied world of tech start-up fundraisings; Recent eye-catching start-up fundraisings tell only part of story

June 19, 2014 3:17 pm

Welcome to the varied world of tech start-up fundraisings

By Richard WatersAuthor alerts

When it comes to putting money into high-flying tech start-ups, not all investments are created equal.

The bald numbers that have hit the headlines after recent eye-catching fundraisings – such as Uber’s $18.2bn valuation two weeks ago – tell only part of the story. In reality, the varied terms of this and other deals have made direct comparisons misleading.

There is also a risk that, with the valuations of late-stage private tech companies booming once again, the fundraising tactics involved will store up trouble for initial public offerings to come.

Take the Uber deal, which valued the taxi app company at 30 per cent more than Twitter was worth at the time of its own IPO last year. For a start, the Uber figure includes the $1.2bn of new cash raised in its latest round: the pre-money figure, which gives a better measure of the value of the business, was $17bn.

Perhaps even more significant is the fact that investors were not buying ordinary shares but convertible preference stock – in effect, a type of debt that will require the company to make its investors whole if the share price falls below its current level at the time of a future exit.

Some prefs, as they are known, are more attractive than others. When Uber last raised money, less than a year ago, it guaranteed investors a 25 per cent return over the life of the investment, according to two people familiar with the terms. That so-called “ratchet” is particularly attractive in a low-interest rate environment, says one investor, because it brings a decent return while also providing a free call option on a high-growth business.

At the other end of the spectrum are rounds such as the recent fundraising that valued online storage and collaboration company Dropbox at $10bn – at the time a high-water mark for the current batch of tech start-ups, before Uber put it in the shade. The prefs in that case only protect investors if Dropbox is acquired for less than the value of the investment round, said one person familiar with the terms: there is no special treatment in the case of a future IPO.

But for some entrepreneurs caught up in the latest internet boom, conservative structures such as this partial preference are out; chasing headline numbers seems to have become an obsession. Valuations are leaked or, increasingly, boasted about. When Microsoft took a stake in Facebook in 2007, the fast-rising social networking company bragged in a press release that the deal had lifted its valuation to $15bn. Left unsaid were the terms of the instrument issued to Microsoft, which it called simply an “equity stake”.

But straining after a high valuation could come with a sting in the tail if it pushes private-market values to levels that cannot be matched in a later IPO. Companies could be forced to issue more stock to make up a shortfall, diluting other shareholders, says one start-up investor. That can lead to difficult negotiations with key investors at a critical time, says another observer.

The recent correction in high-growth public tech stocks is a reminder that this possibility is more than just theoretical, though prices have since stabilised.

The downside protection may be one reason why valuations for hot tech start-ups in the private markets are seemingly being driven up so fast. The catalogue of investors being sucked into the market now includes not only the traditional venture capital and growth equity investors, but hedge funds, private equity firms and even public-market investors such as mutual funds, all of them chasing the seemingly sure-fire profits from investing in the final round before an IPO.

Investors who see this as a one-way bet should think twice. Lock-up arrangements normally prevent them from selling in the first six months after an IPO. That can be a long and painful wait, as turned out to be the case with Groupon. By the time the lock-up for the online daily deals company had lifted, its stock had fallen 50 per cent below its IPO price.

But even in cases such as this, there may be ways to soften the blow. Zynga’s biggest backers, having already unloaded a relatively moderate $150m worth of shares at the time of the IPO, persuaded the company’s investment banks to relax their lock-up. They then dumped $515m worth of shares on the market before the company’s rank-and-file employees got a chance. It was well-timed: Zynga’s stock price plummeted by nearly half in the remaining two months that the original lock-up period had to run.

For the alert start-up investor, it seems, there is usually some way to guard against the downside.



About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: