Stripe recently raised am $80mm series C round led by Keith Rabois, a well-known VC at Khosla Ventures.
The round valued Stripe at $1.5B meaning the series C investors (Khosla) received ~5% of the company for their $80mm investment.
Many felt that the round of financing over valued the company, and that the latest investors got a bad deal. I disagree, if anything, the founders got the bad deal for pricing themselves too high.
Here’s an explanation of how VC math works, and why these huge valuations make more sense than you’d think:
Liquidation Preference
In many of these big deals, a 1x or 2x liquidation preference is typically granted to the latest investors. This means those latest investors will get 1 or 2 times their money back before anyone else. In Stripe’s case, the latest investors will almost assuredly get back $160mm (2x their investment).
It’s also important to know whether or not the round was participating. If fully participating with no cap Khosla will get 2x its money and then share in the rest of the profits regardless of the sale price.
If a cap is put on the participation (this is most common and more fair) investors will only be able to exercise their 2x preferred return up until a certain sale price. This means that if the company does very well all investors will be treated equally because it’ll be economically adventageous to convert preferred stock to common stock at the acquisition. Things can get even more complicated from here and if you’d like to read about dead zones, economic incentives etc. this blog has some good resources: http://capgenius.com/2011/03/31/participatingpfd/
Some Example Scenarios for Context
- These assume previous investors didn’t get participating preferred, which is unlikely—but makes the example easier
- They also assume Khosla got 2x Liquidation Preference and participation capped at 2x
Scenario 1: Stripe sells for $1B (less than the round of financing valued them at) and Khosla exercises its participating preferred:
Scenario 2: Stripe sells for $2B and Khosla exercises its participating preferred again:
Scenario 3: Stripe sells for $10B and Khosla does not exercise its participating preferred because there is a cap & converts to common stock.
Let me know if I made any errors and I’ll fix them. Also, let me know if you have any questions: ali @ coventure .us
Got a Request to Address Scenarios Where Snapchat could be worth noth of $3B or Stripe to be worth ~$10B*
Without going into detail—because I’m not taking sides on this:
(1) Snapchat: it’s the second biggest photo-sharing app in the country—bigger than Instagram. Is it work $3B to Facebook to maintain its leadership across mobile photosharing? Probably.
Also, Snapchat is a better place to serve ads than on Facebook because a user would have to stare at the ad while waiting for a flashed image to show up. Different ad-techniques will need to be tested—but it’s just one way the company could make money.
(2) Stripe: lots has been said against its potential increase in valuation—but because Stripe has become the payment processor of choice for new startups, it means its client base will likely grow in value.
I’m not close enough to either company to comment further.
