What’s Pre-IPO Worth?

A friend of mine works for Rivian. I asked if he has thoughts on their expected IPO valuation of $80 billion
He said – you know we have not delivered one car yet? Not one. But we are asking for a valuation that is more than GM, a company that sells 7 million cars a year. If the markets want to give us $80 billion, we aren’t going to say no. I already have my boat picked out.
Like banks, public companies create money using valuations.

The traditional path billions are either to inherit, or marry up, or win the lottery.

Now the path to fulfilling that American dream is to start a company, raise venture capital, and keep raising capital until you IPO for billions.

Want to learn how WACC affects your valuation? Click Here.

Let’s follow this journey from start to finish…

Venture capitalists are not looking to invest in companies and run them into perpetuity. Their business model is to invest in numerous companies, double down on companies that do well and sell them for a big payday. The only way this model works is when their portfolio companies are successful in raising capital at higher and higher valuations.

Say you start a company, and are among the 2% of startups that successfully raise capital.

You raise $2M Series A at a $10M valuation.

That $2M will burn within months and you will have to raise capital again. But next time you will need to justify at least a $20 million valuation to retain investors’ interest.

After 4-5 times successfully raising capital and increasing valuation 3-5 times at each raise, you are now valued at $1 billion. Such companies are called unicorns and can be candidates for IPO.

Private company investors are incentivized to push valuations higher at each funding round to show appreciation of their assets under management. And since private companies’ investments are outside the purview of regulators, investors have free reign on valuations.

I have valued WeWork for one of its VC investors, who was very bullish on the company and insisted that the value of the company was 60% higher than what I concluded. I made a comment that WeWork’s business model is the same as Regus Space? My client did not like my comment. Six months later valuation of WeWork dropped from $47 billion to $12 billion, and investors had to take a 70% haircut. Today WeWork is worth about $9 billion. 80% lower than the original $47 billion.

The disconnect happens when the company IPOs and all the traditional methods of valuation (income, market, and cost) come into play. As a valuation expert, if I were to value a pre-IPO company like Rivian, or WeWork, or Uber, I cannot justify their valuation using traditional methods.

The fact is pre-IPO valuations are inflated because of two reasons –

1. Private companies’ investments are unregulated.
2. Private investors use non-traditional valuation methods highlighting the potential growth of the company because they are motivated to maximize their investments.

If you can convince investors and markets that your company will show exponential growth, they will give you a valuation that may touch ten digits. By highlighting the growth story of your company, you are almost legally printing money.

Do you know the difference between market value and book value? Click here to learn more.

So next time when you are enticed to invest in an IPO – ask yourself two questions –

1. How much of their valuation is based on future growth?
2. How does a competitor’s valuation stack against them?

A Hollywood set is built by creative and ambitious people.  It is temporary and designed for a specific purpose.  It is a two-dimensional object in a three-dimensional world.  Just like a pre-IPO valuation…

Bharat Kanodia – Founder and Chief Appraiser