Research Handbook on Mergers and Acquisitions
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Research Handbook on Mergers and Acquisitions

Edited by Claire A. Hill and Steven Davidoff Solomon

Global in scope and written by leading scholars in the field, the Research Handbook on Mergers and Acquisitions is a modern-day survey of the state of M & A. Its chapters explore the history of mergers and acquisitions and also consider the theory behind the structure of modern transaction documentation. The book also address other key M & A issues, such as takeover defenses; judges and practitioners' perspectives on litigation; the appraisal remedy and other aspects of Federal and state law, as well as M & A considerations in the structure of start-ups. This Handbook will be an invaluable resource for scholars, practitioners, judges and legislators.
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Chapter 6: A founders’ guide to unicorn creation: how liquidation preferences in M & A transactions affect start-up valuation

Robert P. Bartlett


This chapter investigates the widespread claim that the billion dollar valuations of ‘unicorn’ start-ups are unreliable because of the manner in which founders bargain for these valuations with their venture capital (VC) investors. In particular, unicorn skeptics posit that VC investors agree to use these valuations in exchange for receiving enhanced preferred stock preferences, particularly enhanced liquidation preferences that are payable on a sale of the company. By examining how liquidation preferences affect expected returns of founders and VC investors, this chapter argues that unicorn valuations are indeed unreliable measures of firm value but not for the reasons suggested by unicorn skeptics. While offering enhanced liquidation preferences to an investor can overcome the reduction in expected returns caused by financing a firm at a higher valuation, doing so will generally be more detrimental to a founder’s expected returns than if the financing were done at a lower valuation using a conventional liquidation preference. Rather, this chapter argues that unicorn valuations are unreliable measures of firm value for the same reason that all start-up valuations are unreliable measures of firm value – namely, the common practice among VC investors to price VC financings as if they are purchasing common stock when they are acquiring preferred stock with downside economic protections. As a result of this practice, the reported valuations of unicorns and non-unicorns alike can be significantly higher than the enterprise value an investor is implicitly placing on a firm when financing it. For founders and prior stockholders, this insight has important implications for understanding the effective enterprise value being used in a financing and avoiding unintended dilution.

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