Overall dollar for dollar it's even or in the black for Fidelity for what it's worth because of the massive Uber write ups.
Seems like a non-event to me, people just want to believe these valuations are insane. Are you really feeling that much better that Snapchat is worth $10bn instead of $15bn if you hate Snapchat?
The event is not the mark-down, but the publicity of it. Most of the mark-downs of privately-held startups happen behind closed doors, and they are only visible when new rounds are announced (and only if they include the valuation).
Having Fidelity investing in startups adds a whole new layer of public disclosure to the VC world, specially relevant in the light of the large number of stale unicorns.
The fact Fidelity is being this transparent is great news for engineers in the startup scene considering or holding jobs at these companies.
No longer can managers keep selling a dream that was last pitched years ago at their last funding round; they'll have to compensate for underwater options with rising salaries or grants to keep talent around. Certain startups have a habit of delaying sharing bad news with their employees to the very brink of collapse; this behavior will now be in check somewhat.
I heard that. Employees need more data to evaluate job offers (especially in this economy where the big guys are offering a lot of cash, and the small guys are offering a lot of cash too but also equity of sometimes dubious value).
If you take equity, you are not only subject to dilutions, but also to other investors getting much more preferential terms to you.
I'm not saying to don't take a job because of shares, RSUs, or options offered, but one needs to take a hard look at these things to figure out what their true worth is. And in most cases, you may only be able to compute a confidence interval and not a point estimate.
Fidelity's disclosure makes this seemingly intractable problem a bit less intractable.
So by publicly devaluing a portfolio company, Fidelity increases that company's hiring costs. How is that in Fidelity's best interest? Sure, they're devaluing the company, but they still have a stake in it... why be so public about the devaluation?
Imagine the lovely conversations these companies' VC backers will be forced to have with their fund investors (who will surely ask about Fidelity writing down the valuations) and with fund auditors (who will surely ask about lowering the carrying value of those investments to reflect recent market developments): "Why is your VC fund carrying company X at that much per share? Fidelity just wrote it down to this much. Please explain."
An immediate consequence of these very public write-downs by Fidelity will be that every other late-stage pre-IPO investor holding stock in these companies will likely write them down too. Further consequences are more difficult to predict. One potential outcome is lower valuations across all investment stages. Another could be less excitement and slower deal cycles. It could get harder to raise capital.
This is the double-edged sword of allowing institutional investors to jump in to pre-IPO companies. They can provide staggering sums of money and allow you to put off your IPO for longer, but they bring with them many of the pain points that an IPO does. Retail investors and HFTs aren't the ones causing boardroom drama over margin and sales numbers, and the institutional guys won't put up with any accounting shenanigans (a la Groupon).
I really wonder if, after all the dust settles, many of these "unicorns" would have been better off IPOing around a $1-5 billion valuation. For sure their early investors will be if the late-round institutional guys are writing down their holdings by this much.
Yea, I think the industry seems to have been caught off guard by how aggressive the mutual funds have been with their mark-to-market valuations. This public data will likely have to be factored into the valuation methodologies of the private investors in these deals. Absent of this, Unicorn valuations were probably going to take a much longer time to deflate.
"We thought it was worth more, and it may well be in the future. But if it's not, that's OK, that's why we have a portfolio of 150 companies; some will lose money. We plan on that happening to x% of our companies, and on average we're still lanning on seeing a #x return on the capital you invested."
In other words, this is absolutely an expected part of VC, even at the late stages.
To play devil's advocate a bit here, the companies that are being devalued (on paper) are by definition the so-called "unicorns", or the outliers that VCs depend on to offset losses to their duds. So if you start knocking off double-digit percentages from a few of these outliers, pretty quickly your portfolio takes a huge hit.
Hypothetical situation with some seriously made-up numbers:
* 2x $100k for 5% investment in companies at say a diluted stake of 2% goes from $10B to 5B
* 5x $100k for 5% investment in companies who go bust
* 3x $100k for 5% investment in companies who are acquired, make 10% returns ($110k per).
Total investment: $1m
Return from non-outliers: (5 x $0) + (3 x $110k) => $330k for a net of -$570k
Return from outliers before devaluation (on paper): 2 x .02 x $10B => $400M
Return from outliers after devaluation (on paper): 2 x .02 x $5B => $200M
At this point, the losses/returns of the non-outliers are in the noise. But man, it hurts to have to explain the "loss" of your upside by such an enormous amount. I don't think VCs would shrug it off as just a part of their overall portfolio, since these are the valuations that prop up the overall performance.
If you invested in the early rounds of any of these unicorns, you probably returned the whole fund with that one investment, even given their devaluing.
Even in that case though, nobody is going to be happy with less money than they thought they had. If Bill Gates woke up tomorrow with half of his money gone, he'd be livid, even though he'd still have more money than he knows what to do with.
They didn't ever have any money. They didn't lose any money. It was all paper valuations, and it's never money until you can buy beer with it; that's just part of investing. Does it suck? Sure, but it's part of the game.
Despite these numbers being entirely made up, they seem to illustrate the counterpoint to your argument perfectly, a 200x return is insane by any standards, sure you'd like it to be 400m, but you're not going to regret getting into VC as a class if this is what the numbers looked like.
One thing to consider is that a power law distribution (which is how VCs see their investments), remains a power law distribution no matter how far you zoom in, so even in the "unicorn" bracket, they expect a few of the unicorns (Uber/The Honest Co) to do most of the work.
According to accounts there were bidders from 2B to 3.5B and Fidelity came in at 4.5B at the last second to win the bid. The fact that they now wrote it down to the range others were bidding at is essentially meaningless.
it's not meaningless. It's a data point that adds to support the theory that late stage private valuations are too high and companies should be going public sooner.
Is it undesirable, though? Maybe I am misunderstanding what Fidelity is doing, but it seems to be a careful reconsideration of the very high valuations placed on these startups. This kind of re-adjustment is exactly what would be necessary to keep the market stable and avoid a runaway bubble, right?
That's my read too - if we want to prevent a pop we need to be letting air out of the balloon regularly.
Some skepticism from investors is good, more due diligence re: valuation is good. This is a pretty mild correction overall, which is good for everyone.
I'd be much more worried if Fidelity were snapping up startup shares at ever-higher valuations without ever reckoning actual performance.
As people who work in the industry, this might mean a mild slowdown in hiring as funding becomes a bit more difficult, but it also may prevent the catastrophic alternative which is the bottom falling out from under us and massive tech-sector unemployment.
Personally I think all of these recent announcements are good for startup employees. For the last few years some of us have been expressing a lot of skepticism about the real value of startup options and how much they can realistically exit for. Between valuation write-downs like this, and the face-plant IPOs of the last couple of years, I think people are starting to see the true value of startup options and I hope it results in people being much more discerning about how they're being compensated.
One thing I read that isn't often mentioned is how liquidation preference for late rounds can drive a lot of these insane valuations.
For example, let's say you raise $250MM in a series E at a 10B post money. As a company/founder, this makes you look awesome on paper and super valuable as a company. Meanwhile, the series E investors usually have the top priority for liquidation, meaning the risk is actually pretty small, since the sale/IPO value would have to go below 250MM before you lose money.
The real people getting screwed by these paper unicorns though are the late stage employees being sold options as compensation.
But Fidelity isn't writing down the value of the company, it's writing down the value of its shares. Do you have any guesses as to what this means, given they are probably the most senior equityholders on this investment?
My suspicion (from experience in the mutual fund industry) is that this is tax accounting related. Overly simplistic explanation: Mutual funds typically distribute short term capital gains at year-end, which is taxed as ordinary income (~40%), not capital gains (~15%).
Managers of funds that hold private securities actually have the choice to 'mark down' the prices of their securities in any given month. Think of it like valuing a house - if you want to value your total net worth, you can mark your price as what you want, to an extent (see Trump). Managers often use this flexibility to 'bury' losses in down times, or for tax advantages.
Finally, can't agree enough about who loses in these cases. Employees who vastly over-value options are the folks who lose in this case. Investments made by institutional folks like Fidelity are too small to even register as a blip to their overall funds, and those funds are diversified and managed to handle downturns in sectors like this.
That's not exactly fair. They hold many assets, so of course any action on any individual asset may not have a significant effect. However, if they behave similarly across all similar assets, it will have an effect on the overall fund.
I think the percent of holdings argument is going to apply to these funds at Fidelity even if you take all the startups they own together. I guess "tens of millions" becomes excessively dismissive though.
Sure but even still, suppose an analyst saves all of Fidelity's clients 1M in two days worth of work. We can't dismiss that as silly because that savings is so small compared to 5 trillion AUM, right?
I'd also like someone who understands the issue well to let us know whether these mark downs have any tax implications to begin with. I think it might sometimes be the case that marking down such a holding would allow recognition of a tax loss but I don't think that is going on here.
Stasis' logic is along the right lines - you need to think about it in terms of portfolio management strategy. Effectively, the manager is trying to switch as much of the gains of their fund from being taxed at 40% to being taxed at 15%. A decent explanation here: http://www.nicholasfunds.com/dividend_info.html
You're right that it won't be a large drop in the bucket. It's not news because it's a large drop in a bucket, it's news because its a valuation change on companies many here follow. Nonetheless, one could object to poor management if Fidelity didn't take this action, regardless of size.
Note - this only gets at the 'why now' part of the motivation. What it means for 1) their internal company valuations and 2) implications for shareholders without liquidation preferences is more interesting.
Can you explain the mechanism where it is a tax loss and show where Fidelity has used it? That sounds like a gotcha, but I'm genuinely curious if it is clearly the case that they can recognize a tax loss here.
I think the mark down mostly does two things. It allows Fidelity to honestly inform their customers what they hold, and it signals to the startups that things aren't necessarily going the way Fidelity would like to see them go.
If these securities have been held for <1 year, their gain/loss goes into the short term bucket. So losses (in this case, writedowns) can offset the size of distribution, which is a bad deal for investors.
To a personal investor (e.g. mentioned in the world of WealthFront/Betterment), this is 'tax loss harvesting'.
Yeah agreed. The linked article mentions distributing income but snapchat has no dividends so it seems irrelevant. I'm not clear how this has any effect on Fidelity's taxes for 2015. It seems like its just bringing the valuations closer to what Fidelity expects they are worth so there are no surprises later.
What do you mean by this "The real people getting screwed by these paper unicorns though are the late stage employees being sold options as compensation"?
I'm currently a student job searching and this seems pretty relevant.
Employees and Investors of private companies hold different class(es) of stock.
Employees (and Founders) have common stock, while Investors get preferred stock.
Preferred stock carries with it a "liquidation preference", which basically means holders of that stock get paid out first during a liquidity event, including some multiple of their original investment. What ever is left, is divided among the holders of common stock.
If the company is publicly traded, then all owners of stock hold the same class of stock (common).
You get options offered at a strike price that (for tax reasons) usually matches the market value of the company. If the company is way overvalued on paper, that makes the options essentially worthless, as the strike price is higher than what you could trade the shares for.
Yeah everyone here seems convinced they're trying to game some system. I think Occam's razor is right here. They really just think those companies are worth less than they were.
But, I still wouldn't worry about that too much directly. As the article mentions, it's more art than science. If I were Zenefits I don't think I'd be sweating it.
Basically, Fidelity lost money investing in private companies. Only reason the Fidelity private investment is in the black because of the higher valuation of Uber Series E round that "artificially" inflated the value of the Fidelity shares from previous Uber Series D round.
The reality here is is Fidelity is getting ahead of the curve. Chances are pretty good interest rates are going to rise in Dec. Some money will follow to these risk free interest instruments (savings, Bonds) Why take such a risk on on a start up with say a 1 in 50 chance of payout, when you can get 1% return on investment at no risk?
Unicorns can only exist in ZIRP. (Zero interest Rate Policy)
So Fido wasn't great at investing in emergent technology. It paid too much and chased what it saw as 'performance,' applying a Wall Street paradigm to something entirely different. I don't think this result is a surprise, and I'd say it's very, very good for the health of the technology economy.
1) You have a company you know is worth $50 million.
2) You are smart; you scream and yell and tell everyone it's worth $1.3 billion.
3) Now even the smartest analyst is going to say you are worth $750 million.
4) A year later, the market is down. You are really worth $40 million.Some executives at big co "swoop" you for $550 million in what they call a steal + you needed the money.
Lots of bombed IPOs recently followed this track. If they IPOed at 1 (what they were likely worth) and went to 1.2 they'd be seen as a solid company with great growth potential.
Instead they IPO at 5, fell to 2 and are really worth 1. Now they're seen as a hopeless train wreck that can't be saved and sign of a "bubble."
A silly high paper valuation during funding rounds makes for fun press releases, but it can cause a ton of headaches later (if the company isn't actually worth those amounts... and most aren't).
Hopefully this doesn't border on the "conspiracy theory" side too closely, but if a company is able to IPO at 5x what they're "actually" worth, the company still gets that cash, so what happens to the stock price after that doesn't matter from the perspective of the company accountants.
A couple of examples:
Groupon: IPOed at $20/share, raising ~$700m. They are currently trading in the $2.70 range. From a company perspective, they killed it by IPO-ing -- they took $700m worth of cash, most of which I believe they still have (as of a few months ago they still had ~$1bn in cash equivalents).
Zynga: IPOed at $10/share, raising roughly $1bn. They are currently trading at $2.48. Same basic story as above. Their current market cap is just about double what they raised in cash at their IPO.
So from two perspectives, these companies did exceedingly well: their investors and founders likely cashed out most of their chips at IPO, so they made a killing, and the company received a tremendous amount of cash for their coffers. Sure, Groupon and Zynga booted their CEOs, but they don't care much, and I'm sure whoever they got to replace them is handsomely compensated (regardless of how well they do).
So who gets screwed? Employees, who don't get to sell their shares until the company has tanked, and whichever investors are stuck holding the bag after IPO. But after the IPO, there's not much of an incentive for these early people to care about that; if they get canned, who cares, they'll cash out their $100m worth of compensation and go work at some other company down the street.
Well yes, "bombed IPO" is a relative term. If you float a pile of trash onto the stock market and rake in a lot of $$$ then sure cash out and go live on a nice tropical island somewhere while leaving a smoking crater behind full of employees holding worthless options. From the early investors standpoint that's a win.
However, that can only happen so many times before the "suckers" that were buying these things at IPO catch on and lose their appetite. That sort of thing is in part what's happening and in part why these write downs are occurring. The paper valuation during funding rounds is only real if the "real market" (i.e. everyone, not just a few VCs writing founders a cheque) is willing to buy shares at that value. If the market continues to get more skeptical, and there's every indication that this will continue to be the case, then down rounds are an almost certainty moving forward for many firms.
That's also a big problem for employee options, which typically only have value if the valuation keeps skyrocketing.
Im not on the side of VCs, but many are victims, not guilty, of this.
Usually, institutional investors(e.g. Fidelity) give money to VC funds that spend most of their time finding good and reasonable investments.
However, Fidelity and other institutional investors have been investing in late-stage deals, "cutting off" many VC funds and increasing valuation of companies.
So, here is the list of unicorns that Fidelity has invested with individual gains/losses shown. Turns out for the entire unicorn fund, it is about 36% above cost.
This undoubtedly has to do with the $2 billion haircut that Square's late-stage investors are taking on its IPO. But it's really Fidelity's fault. If you offer money at ridiculous valuations, guess what? People are going to take you up on it, and you're going to lose money.
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[ 3.4 ms ] story [ 150 ms ] threadSeems like a non-event to me, people just want to believe these valuations are insane. Are you really feeling that much better that Snapchat is worth $10bn instead of $15bn if you hate Snapchat?
Having Fidelity investing in startups adds a whole new layer of public disclosure to the VC world, specially relevant in the light of the large number of stale unicorns.
No longer can managers keep selling a dream that was last pitched years ago at their last funding round; they'll have to compensate for underwater options with rising salaries or grants to keep talent around. Certain startups have a habit of delaying sharing bad news with their employees to the very brink of collapse; this behavior will now be in check somewhat.
If you take equity, you are not only subject to dilutions, but also to other investors getting much more preferential terms to you.
I'm not saying to don't take a job because of shares, RSUs, or options offered, but one needs to take a hard look at these things to figure out what their true worth is. And in most cases, you may only be able to compute a confidence interval and not a point estimate.
Fidelity's disclosure makes this seemingly intractable problem a bit less intractable.
An immediate consequence of these very public write-downs by Fidelity will be that every other late-stage pre-IPO investor holding stock in these companies will likely write them down too. Further consequences are more difficult to predict. One potential outcome is lower valuations across all investment stages. Another could be less excitement and slower deal cycles. It could get harder to raise capital.
I really wonder if, after all the dust settles, many of these "unicorns" would have been better off IPOing around a $1-5 billion valuation. For sure their early investors will be if the late-round institutional guys are writing down their holdings by this much.
"We thought it was worth more, and it may well be in the future. But if it's not, that's OK, that's why we have a portfolio of 150 companies; some will lose money. We plan on that happening to x% of our companies, and on average we're still lanning on seeing a #x return on the capital you invested."
In other words, this is absolutely an expected part of VC, even at the late stages.
Hypothetical situation with some seriously made-up numbers:
* 2x $100k for 5% investment in companies at say a diluted stake of 2% goes from $10B to 5B
* 5x $100k for 5% investment in companies who go bust
* 3x $100k for 5% investment in companies who are acquired, make 10% returns ($110k per).
Total investment: $1m
Return from non-outliers: (5 x $0) + (3 x $110k) => $330k for a net of -$570k
Return from outliers before devaluation (on paper): 2 x .02 x $10B => $400M
Return from outliers after devaluation (on paper): 2 x .02 x $5B => $200M
At this point, the losses/returns of the non-outliers are in the noise. But man, it hurts to have to explain the "loss" of your upside by such an enormous amount. I don't think VCs would shrug it off as just a part of their overall portfolio, since these are the valuations that prop up the overall performance.
One thing to consider is that a power law distribution (which is how VCs see their investments), remains a power law distribution no matter how far you zoom in, so even in the "unicorn" bracket, they expect a few of the unicorns (Uber/The Honest Co) to do most of the work.
Some skepticism from investors is good, more due diligence re: valuation is good. This is a pretty mild correction overall, which is good for everyone.
I'd be much more worried if Fidelity were snapping up startup shares at ever-higher valuations without ever reckoning actual performance.
As people who work in the industry, this might mean a mild slowdown in hiring as funding becomes a bit more difficult, but it also may prevent the catastrophic alternative which is the bottom falling out from under us and massive tech-sector unemployment.
Personally I think all of these recent announcements are good for startup employees. For the last few years some of us have been expressing a lot of skepticism about the real value of startup options and how much they can realistically exit for. Between valuation write-downs like this, and the face-plant IPOs of the last couple of years, I think people are starting to see the true value of startup options and I hope it results in people being much more discerning about how they're being compensated.
For example, let's say you raise $250MM in a series E at a 10B post money. As a company/founder, this makes you look awesome on paper and super valuable as a company. Meanwhile, the series E investors usually have the top priority for liquidation, meaning the risk is actually pretty small, since the sale/IPO value would have to go below 250MM before you lose money.
The real people getting screwed by these paper unicorns though are the late stage employees being sold options as compensation.
My suspicion (from experience in the mutual fund industry) is that this is tax accounting related. Overly simplistic explanation: Mutual funds typically distribute short term capital gains at year-end, which is taxed as ordinary income (~40%), not capital gains (~15%).
Managers of funds that hold private securities actually have the choice to 'mark down' the prices of their securities in any given month. Think of it like valuing a house - if you want to value your total net worth, you can mark your price as what you want, to an extent (see Trump). Managers often use this flexibility to 'bury' losses in down times, or for tax advantages.
Finally, can't agree enough about who loses in these cases. Employees who vastly over-value options are the folks who lose in this case. Investments made by institutional folks like Fidelity are too small to even register as a blip to their overall funds, and those funds are diversified and managed to handle downturns in sectors like this.
Here's one of the Fidelity funds invested in Snapchat:
https://fundresearch.fidelity.com/mutual-funds/composition/3...
It's got $40 billion under management.
There's a document findable from there that lists their Snapchat investment as $10 million (Prospectus and Reports->Monthly Holdings report).
The number 1 holding of that fund is $2,192,901,654 of Apple. So they get roughly $10 million each time Apple pays a quarterly dividend.
I'd also like someone who understands the issue well to let us know whether these mark downs have any tax implications to begin with. I think it might sometimes be the case that marking down such a holding would allow recognition of a tax loss but I don't think that is going on here.
You're right that it won't be a large drop in the bucket. It's not news because it's a large drop in a bucket, it's news because its a valuation change on companies many here follow. Nonetheless, one could object to poor management if Fidelity didn't take this action, regardless of size.
Note - this only gets at the 'why now' part of the motivation. What it means for 1) their internal company valuations and 2) implications for shareholders without liquidation preferences is more interesting.
I think the mark down mostly does two things. It allows Fidelity to honestly inform their customers what they hold, and it signals to the startups that things aren't necessarily going the way Fidelity would like to see them go.
If these securities have been held for <1 year, their gain/loss goes into the short term bucket. So losses (in this case, writedowns) can offset the size of distribution, which is a bad deal for investors.
To a personal investor (e.g. mentioned in the world of WealthFront/Betterment), this is 'tax loss harvesting'.
I'm currently a student job searching and this seems pretty relevant.
Employees (and Founders) have common stock, while Investors get preferred stock.
Preferred stock carries with it a "liquidation preference", which basically means holders of that stock get paid out first during a liquidity event, including some multiple of their original investment. What ever is left, is divided among the holders of common stock.
If the company is publicly traded, then all owners of stock hold the same class of stock (common).
But, I still wouldn't worry about that too much directly. As the article mentions, it's more art than science. If I were Zenefits I don't think I'd be sweating it.
Unicorns can only exist in ZIRP. (Zero interest Rate Policy)
In laymen's terms it's called a bubble.
2) You are smart; you scream and yell and tell everyone it's worth $1.3 billion.
3) Now even the smartest analyst is going to say you are worth $750 million.
4) A year later, the market is down. You are really worth $40 million.Some executives at big co "swoop" you for $550 million in what they call a steal + you needed the money.
Instead they IPO at 5, fell to 2 and are really worth 1. Now they're seen as a hopeless train wreck that can't be saved and sign of a "bubble."
A silly high paper valuation during funding rounds makes for fun press releases, but it can cause a ton of headaches later (if the company isn't actually worth those amounts... and most aren't).
A couple of examples:
Groupon: IPOed at $20/share, raising ~$700m. They are currently trading in the $2.70 range. From a company perspective, they killed it by IPO-ing -- they took $700m worth of cash, most of which I believe they still have (as of a few months ago they still had ~$1bn in cash equivalents).
Zynga: IPOed at $10/share, raising roughly $1bn. They are currently trading at $2.48. Same basic story as above. Their current market cap is just about double what they raised in cash at their IPO.
So from two perspectives, these companies did exceedingly well: their investors and founders likely cashed out most of their chips at IPO, so they made a killing, and the company received a tremendous amount of cash for their coffers. Sure, Groupon and Zynga booted their CEOs, but they don't care much, and I'm sure whoever they got to replace them is handsomely compensated (regardless of how well they do).
So who gets screwed? Employees, who don't get to sell their shares until the company has tanked, and whichever investors are stuck holding the bag after IPO. But after the IPO, there's not much of an incentive for these early people to care about that; if they get canned, who cares, they'll cash out their $100m worth of compensation and go work at some other company down the street.
However, that can only happen so many times before the "suckers" that were buying these things at IPO catch on and lose their appetite. That sort of thing is in part what's happening and in part why these write downs are occurring. The paper valuation during funding rounds is only real if the "real market" (i.e. everyone, not just a few VCs writing founders a cheque) is willing to buy shares at that value. If the market continues to get more skeptical, and there's every indication that this will continue to be the case, then down rounds are an almost certainty moving forward for many firms.
That's also a big problem for employee options, which typically only have value if the valuation keeps skyrocketing.
They raised 1B in that round.
Usually, institutional investors(e.g. Fidelity) give money to VC funds that spend most of their time finding good and reasonable investments.
However, Fidelity and other institutional investors have been investing in late-stage deals, "cutting off" many VC funds and increasing valuation of companies.
http://www.bain.com/publications/articles/shadow-capital-ste...
http://www.valuewalk.com/wp-content/uploads/2015/11/Fidelity...
$32 M $16.74 M $14.77 M
I'm not surprised
http://fortune.com/2015/11/12/fidelity-marks-down-tech-unico...