On the Asymmetry of Risk in a Unicorpse: A Good Case Study

 

Yesterday, I wrote about the problems with Unicorns and their preferential treatments of investors.

Today, I wanted to make the asymmetry realer.

Consider the decision facing the board when it had an 825 million dollar deal on the table.

The board was considering four options in that order

1. Go public and be valued at more than 1 billion
2. Accept an 825 million dollar deal
3. Sell at a lot less
4. Keep struggling alon

The board, probably feeling optimistic decided to skip the 825 million dollar deal because the board felt that the upside of an IPO was worth the risk.

The question is what risk was the board considering and are these aligned for all stakeholders.

For the preferred investor, option 3 is more valuable than option 4 and for the employees option 3 is not an option worth considering.

Let’s explain it with numbers.

If the deal closes at 825 million, preferred investors make ~4$ a share. If the deal closes at 425 million, the preferred investors make 3$ a share. If the IPO happens, the preferred investors may make 5$ a share.

If you think that an IPO has a 20% chance of happening and a 425 million dollar deal has a 70% of happening then what you are doing is saying I am taking a chance at 20% upside with a 25% downside. Not a bad bet. Especially, if the downside bet is still a positive outcome. Option 4, continue to go at it is the worst option because the downside risk is to lose everything.

For the employees, however, an 825 million acquisition is worth 4$ a share, and a deal at 425 million is worth 0.44$ a share and is no different than struggling along. Your stock is worthless at 425 million so you might as well keep trying.

And if I were an employee, I would like the choices the board to be 1, 2 and 4, whereas the board is incented to choose between 1, 2 and 3.

And because the employees are not a stakeholder and not even a shareholder, the right decision for the preferred investors was made.