The Mutual Fund Mark Down

For months now, a debate has raged on Twitter about the health of the late-stage, pre-IPO market for investing in startups. Many believe its overheated. Fueling this view, Fidelity, an active pre-IPO investor, recently marked down investments in several pre-IPO high-flyers.

As Marvin Gaye asked, “What’s going on?”

Prior to my nearly two decades as a VC in Silicon Valley, I spent a few years on Wall Street. I can briefly share my perspective to answer Marvin’s question.

  1. Most investors, public or private, report on a quarterly basis. VCs usually report to their LPs quarterly, and sometimes mark down companies in value if underlying financial targets aren’t being met and/or the multiples of market-comparable companies trade down.
  2. When VCs mark down a portfolio company, it’s a private signal — only LPs in those funds see the data and are usually bound under strictly confidentiality agreements not to share this information.
  3. Mutual Funds like Fidelity, however, have regulatory filing obligations to value their private stock holdings on a quarterly basis, and these filings are public record. These valuation mechanisms may differ and penalize new business models, but are usually driven by some combination of underlying operating performance relative to financial plans AND market-comparable assessments.
  4. These days, auditors play an important role in deriving valuations on private companies.  Quarterly valuations are sometimes audited or at least reviewed by auditors; year-end numbers are typically audited.

Now, with respect to the recent news reported in Fortune about Fidelity’s larger mark downs this week, GGV is not an investor in these companies, but here is how I interpret them:

  1. A round-number mark down (e.g. 25% on Snapchat) might suggest a cut to valuation based on an assessment that the public market valuations for these types of companies has come down. It is unlikely to specifically result from underlying weakness in Snapchat’s business. In fact, Fidelity and its auditors are probably not looking at revenue, but more likely usage statistics as a gauge on the business (which appear, from the outside, to be doing very well).
  2. A bigger markdown (e.g. 48% to Zenefits) probably reflects some of both company performance relative to the pre-stated plan AND an overall reduction in value of market comparables. Keep in mind, however, that a company like Zenefits is probably still growing insanely fast; it might just not be growing quite as fast as was previously projected when Fidelity invested. So, one should NOT conclude from Fidelity’s re-valuation that this business is faltering – in fact, its likely continuing to do very well.

In writing this, it occurred to me that the key question for high-growth founders and CEOs is as follows: “Do you want the valuation of your private startup to be public?” I’d guess most would answer “no,” but the reality of taking investment from mutual funds is that they are bound to regulatory filing obligations such that a founder is at the mercy of being marked down in a very swift, public manner.

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