Ilya Strebulaev

Fast-growing innovative companies - startups - operate unlike other businesses and raise money in similarly distinctive ways. Eschewing traditional banks and equity markets, they turn to a startup financing ecosystem that includes corporate and institutional VC funds, crowdfunding, angel investors, growth equity, and private equity. We start by discussing key relevant stylized facts and how they lead to contracting frictions. We then discuss the various investment contracts used by startups and… Show more

Fast-growing innovative companies - startups - operate unlike other businesses and raise money in similarly distinctive ways. Eschewing traditional banks and equity markets, they turn to a startup financing ecosystem that includes corporate and institutional VC funds, crowdfunding, angel investors, growth equity, and private equity. We start by discussing key relevant stylized facts and how they lead to contracting frictions. We then discuss the various investment contracts used by startups and their associated cash flow and control rights. Given that startups almost invariably raise multiple rounds of funding, we then discuss contracting issues associated with the evolution of cash flow and control rights. We finally discuss approaches to valuing startups, their financial securities, and the impact of contractual terms on valuation. Show less

We develop 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 post-money valuations exceed fair values by 39%. Ignoring future rounds overstates the valuation impact of liquidation preferences by more than 100%. Counterintuitively, future “investor-friendly” rounds transfer value from current investors… Show more

We develop 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 post-money valuations exceed fair values by 39%. Ignoring future rounds overstates the valuation impact of liquidation preferences by more than 100%. Counterintuitively, future “investor-friendly” rounds transfer value from current investors to founders and other common shareholders. Future terms closely resemble current terms, which makes current “investor-friendly” terms much less valuable to investors. Our valuations predict outcomes and the prices reported by specialized venture capital investors but are lower than values reported by mutual funds and dramatically higher than the values companies report for tax purposes. Show less

We survey over one thousand venture capitalists (VCs) on how the COVID-19 pandemic has affected their decisions and investments. Although individual funds and portfolio companies have been dramatically impacted, VCs expect aggregate returns to be largely unchanged because winners have offset losers. This suggests the primary impact of COVID-19 has been an increase in volatility and uncertainty. Consistent with that, VCs report initially delaying investment due to a difficulty evaluating deals… Show more

We survey over one thousand venture capitalists (VCs) on how the COVID-19 pandemic has affected their decisions and investments. Although individual funds and portfolio companies have been dramatically impacted, VCs expect aggregate returns to be largely unchanged because winners have offset losers. This suggests the primary impact of COVID-19 has been an increase in volatility and uncertainty. Consistent with that, VCs report initially delaying investment due to a difficulty evaluating deals and an expectation that future financings will offer investors more downside protections. We find only moderate evidence of disruption to VC capital flows, with investment expected to be down less than one-fifth, and only one-sixth of VCs reporting any pressure from limited partners to conserve capital. Despite the historical importance of in-person meetings, VCs do not report difficulty finding quality entrepreneurs. We also find little change in how VC allocate their time in the pandemic compared to before the pandemic. Show less

We study gender and race in high-impact entrepreneurship using a tightly controlled randomized field experiment. We sent out 80,000 pitch emails introducing promising but fictitious start-ups to 28,000 venture capitalists and angels. Each email was sent by a fictitious entrepreneur with randomly assigned gender and race. Female entrepreneurs received 9% more interested replies than males pitching identical projects and Asians received 6% more than Whites. Our results suggest that investors do… Show more

We study gender and race in high-impact entrepreneurship using a tightly controlled randomized field experiment. We sent out 80,000 pitch emails introducing promising but fictitious start-ups to 28,000 venture capitalists and angels. Each email was sent by a fictitious entrepreneur with randomly assigned gender and race. Female entrepreneurs received 9% more interested replies than males pitching identical projects and Asians received 6% more than Whites. Our results suggest that investors do not discriminate against female or Asian entrepreneurs when evaluating unsolicited pitch emails and that future research on investor biases should focus on networks and in-person interactions. Show less

We survey 885 institutional venture capitalists (VCs) at 681 firms to learn how they make decisions across eight areas: deal sourcing; investment decisions; valuation; deal structure; post-investment value-added; exits; internal organization of firms; and relationships with limited partners. In selecting investments, VCs see the management team as more important than business related characteristics such as product or technology. They also attribute more of the likelihood of ultimate investment… Show more

We survey 885 institutional venture capitalists (VCs) at 681 firms to learn how they make decisions across eight areas: deal sourcing; investment decisions; valuation; deal structure; post-investment value-added; exits; internal organization of firms; and relationships with limited partners. In selecting investments, VCs see the management team as more important than business related characteristics such as product or technology. They also attribute more of the likelihood of ultimate investment success or failure to the team than to the business. While deal sourcing, deal selection, and post-investment value-added all contribute to value creation, the VCs rate deal selection as the most important of the three. We also explore (and find) differences in practices across industry, stage, geography and past success. Show less

We develop a valuation model for venture capital-backed companies and apply it to 135 U.S. unicorns -- private companies with reported valuations above $1 billion. We value unicorns using financial terms from legal filings and find reported unicorn post-money valuations average 48% above fair value, with 13 being more than 100% above. Reported valuations assume all shares are as valuable as the most recently issued preferred shares. We calculate values for each share class, which yields lower… Show more

We develop a valuation model for venture capital-backed companies and apply it to 135 U.S. unicorns -- private companies with reported valuations above $1 billion. We value unicorns using financial terms from legal filings and find reported unicorn post-money valuations average 48% above fair value, with 13 being more than 100% above. Reported valuations assume all shares are as valuable as the most recently issued preferred shares. We calculate values for each share class, which yields lower valuations because most unicorns gave recent investors major protections such as IPO return guarantees (15%), vetoes over down-IPOs (24%), or seniority to all other investors (30%). Common shares lack all such protections and are 56% overvalued. After adjusting for these valuation-inflating terms, almost one-half (65 out of 135) of unicorns lose their unicorn status. Show less

Venture capital-backed companies account for 41% of total US market capitalization and 62% of US public companies’ R&D spending. Among public companies founded within the last fifty years, VC-backed companies account for half in number, three quarters by value, and more than 92% of R&D spending and patent value. The US did not spawn top public companies at a higher rate than other large, developed countries prior to 1970s ERISA reforms, but produced twice as many after it. Using those reforms… Show more

Venture capital-backed companies account for 41% of total US market capitalization and 62% of US public companies’ R&D spending. Among public companies founded within the last fifty years, VC-backed companies account for half in number, three quarters by value, and more than 92% of R&D spending and patent value. The US did not spawn top public companies at a higher rate than other large, developed countries prior to 1970s ERISA reforms, but produced twice as many after it. Using those reforms as a natural experiment suggests that the US VC industry is causally responsible for the rise of one-fifth of the current largest 300 US public companies and that three-quarters of the largest US VC-backed companies would not have existed or achieved their current scale without an active VC industry. Show less