Abstract

This paper develops the first option pricing model of venture capital-backed companies and their security values that incorporates the dilutive future financing rounds prevalent in the industry. Applying our model to 19,000 companies raising 37,000 rounds shows that preferred contractual features make the most recently issued preferred shares worth on average 56% more than common shares. While future rounds have a negligible impact on most securities, they significantly impair the value of securities with high liquidation multiples or seniority. Counterintuitively, future “investor-friendly” rounds transfer value from current investors to founders and other common shareholders, significantly reducing the value of many preferred protections. Our model-implied valuations predict exit values, price changes, and outcomes. Modeled security values are consistent with prices reported by specialized intermediaries but suggest dramatic underreporting of common share values for tax purposes.

Authors

Will Gornall, University of British Columbia (UBC) – Sauder School of Business
Ilya A. Strebulaev, Stanford University – Graduate School of Business; National Bureau of Economic Research