KROLL-在市场下跌中评估清算偏好的价值-2025

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PortfolioValuationWhitepaper

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AssessingtheWorthofLiquidationPreferencesAmidMarketDeclines

Howdopriorliquidationpreferencerightsholdup

indown-roundfinancingevents?

Authors:StevenNebb,ManagingDirector,KrollLLC,NavoditMittal,Director,KrollGlobalSolutionsLLP

ThebullmarketrunforVCinvestmentsoverthe2010to2021periodsawtheriseoftheunicorns,expandedgrowthandsignificantcapitalallocatedtotheventuresector.

ComingoutofCOVID,thisenvironmenthasshifteddramatically.Overthepastdecade,liquidationpreferences(LPs)andrelatedrightswerecertainlystillconsidered,buttheirimportancequicklyfadedasgrowthandvalueincreaseddramatically.Atthispoint,it

maybeworthrevisitingthepreferencetermsandtheirimpactontheestimationoffairvalueinamorechallengingenvironment.

In2024,manystartupsraisedfundsatflator

lowervaluations(downrounds)comparedtothe

elevatedlevelsseenin2021,regardlessoftheir

stageorsize.However,investorsarenowfavoringcertainsectorslikeAI,healthcareandrenewables,aswellasleanerstartupswithclearpathsto

profitability,overthosefocusedsolelyongrowth.Since2023,therehasbeenanincreaseininsiderandbridgeroundsoffinancingduetohighercostofcapitalandmacroeconomicuncertainty.Facingchallengesinraisingnewcapital,companieswithimminentliquidityissuesarecompelledtosecurefundsthroughdownrounds,whichnegatively

impacttheequitystakesoffounders,employees,andpreviousinvestors.However,somefoundersandcompanyownersareattemptingtoavoidtherecognitionofadecliningheadlinevaluethroughvariousfinancingstrategies:

•Useofconvertiblesecurities

•Specializedterms

Seniorandincreasingpreferences

Materialcumulativedividends

MinimumMOIC(MultipleofInvestedCapital)orIRR(InternalRateofReturn)terms

Qualifiedeventsorcontingent

ownershipcoverage

Participationrights

Betterthanoneconversionratios

•IssuanceofSAFEs(SimpleAgreementsforFutureEquity)withorwithoutcaps

•Moreaggressive,tranchedfinancingswithembeddedcontingenciesforcapitalcalls

Allofthesestrategiesaredilutiveandtypically

indicateadecreaseinvalue;however,fromabasicviewpoint,thesestrategiesenablethereported

headlinevaluesororiginalissuepricestoremain

highwhileobscuringthetrueimpacttheyhaveonthevalueofacompany.

DownsideProtectionfor

EquityInvestors

LPshelpmitigatefinancialriskfornewinvestors,

makinghigh-riskventuresmoreappealing.They

serveasacrucialnegotiatingtool,enablinginvestorstosecurebettertermsduringfuturefundingroundsandallocationofvalueatcertainexitscenarios.LPscaninfluenceastartupsvaluation,assome

PortfolioValuationWhitepaper

investorsmaydemandhigherreturns,potentially

loweringtheoverallvaluation.HighLPscandeternewinvestorssincetheyguaranteehigherreturnsforcurrentinvestorsduringaliquidationevent.LPcanskewtheperceivedvalueofthecompany.Forexample,astartupwitha$250millionvaluation,

$100millioninpreferredstockanda2.0xLPmightendupbeingworthmuchlesstocommon

shareholdersinaliquidationscenario.

AsignificantamountofLPcancreate“flatspots,”wherecertaininvestorsbecomeindifferenttothecompany’sfinalsalepriceacrossvarious

outcomes.Therefore,negotiatingfairand

equitableLPsisessentialforinvestorsand

founders.BothpartiescanconsiderseveralfactorswhilenegotiatingLP:

•Stageofdevelopment(earlystagevs.maturestage)

•Expectedcapitalneedsofthecompanytogettoexitorprofitability

•Marketconditions

•Valuationofthecompany

•Exitstrategy

Intougheconomictimes,securinginvestment—

evenwithseniorLPs—canbevitalforacompany’ssurvival.Withoutthisfunding,thecompanymight

faceseverefinancialchallengesorevenbankruptcy.AlthoughLPssafeguardcurrentinvestors,they

mightdiscouragenewinvestorsifthetermsseem

tooadvantageousforexistinginvestors.Thiscan

affectthecompany’sabilitytosecurefuturefundingrounds.LPsalsoshapeinvestors’perspectiveson

exitstrategies.ThosewithstrongLPsmay

advocateforearlierexitstorecovertheir

investments,whereasinvestorswithweakerLPsmightprefertowaitforahighervaluation.

Forjuniorandcommonshareholders,havingseniorinvestorswithLPscanprovideabufferagainst

downsiderisk.Theseinvestorsaremorelikelyto

supportthecompanyduringdifficultperiods.Ifthecompanysucceedsandgrows,theoverallvaluecanincrease,benefitingallshareholders,includingjuniorandcommonshareholders.Theymaybe

comfortablewithseniorLPsfornewinvestorswhoinvestathighervaluationscomparedtoprevious

rounds.HighorfavorableLPscansometimes

reducethecompany’svaluationbyprioritizing

preferredinvestorreturnsoverthoseofcommonshareholders.Thiscandilutethevalueofcommonequity,impactingthereturnsfoundersand

employeesreceiveduringanexit,especiallyinlow-valuescenariossuchasassetsalesor

distressedmergers.

Incompanieswithcomplexcapitalstructures,LPs

determinetheorderofpayoutsduringaliquidity

eventandcansignificantlyinfluencethedistributionofproceeds,which,ingeneral,disproportionately

benefitspreferredstockholdersrelativetotheir

percentageownershipinthecompany.

UnderstandingtheimpactofdifferenttypesofLPsonacompany’svalueiscrucial,astheycanaffectfinancialoutcomesduringexitevents.

Non-participatingLPstypicallyleadtohighercompanyvaluationsascomparedtomore

favorableLP.Theyprovideasinglepayoutto

preferredshareholdersfirst,withtheremainingproceedsgoingtocommonshareholders.

ParticipatingLPs,ontheotherhand,canresultinlowercompanyvaluationsaspreferred

shareholdersgettheirLPfirstandthensharetheremainingproceedswithcommonshareholders,reducingtheamountavailabletocommon

shareholdersanddilutingtheirequityvalue.

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DynamicsofDownRound

Inthelandscapeofstartupfinancing,down

rounds—wherenewsharesareissuedatalower

valuationthanthepreviousfundinground—have

traditionallybeenmetwithconcernbycompaniesandinvestors.Historically,downroundshavebeenwronglyassociatedwithstrugglingordistressed

companies,leadingtodecreasedemployeemorale,ownershipdilutionandachallengingfuture.

However,thebullmarket,drivenbylowinterest

ratesandexcesssupplyofcapital,createda

scenariowhererobustbusinesseshavevaluation

multiplessignificantlyhigherthanthoseof

comparablepubliccompanies,evenwhenadjustedforgrowth.Consequently,wearewitnessinga

situationwheresecuringnewfinancingwith

favorabletermsisbecomingmoredifficult,forcingcompanieswithimmediateliquidityneedstoraisefundsatlowervaluations.ThequestiontoanswerishowpriorLPsholdupindown-roundfinancingevents,andwhattheimpactshouldbeofnew

termsonpreviouslyprotectiverights?

Inadownround,thetermsforexistinginvestors

canberestructured,oftenenforcinga“pay-to-

play”provision.Thismeanspreferredstock

investorsmayfacepenalties,suchashigher

dilutionorreducedseniority,iftheydonotinvestaspecifiedamountinfuturefinancingrounds.

Tobetterunderstandtheeffectsofdownrounds,examiningreal-worldexamplescanbeinsightful.Hereareafewcasestudiesthatillustratehow

theseconceptsareappliedinpractice:

1Klarna

TheSwedishfintechcompanyKlarna,knownforits“buynow,paylater”services,facedasignificant

downroundin2022.Itsvaluation,whichwas$45.6billioninJune2021,droppedto$6.7billionbyJuly2022,markingan85%decline.Thiswasduetoa

severemarketdownturn,highinflation,rising

interestratesandincreasedlosses.Inresponse,

Klarnadiversifieditsfinancialproducts,

implementedcost-cuttingmeasures,andexpandedintokeymarkets,particularlytheU.S.Attheendof

March2025,Klarnawastradingatavaluationof

$14to$15billioninthesecondarymarketandwasconsideringanIPOinH12025whichhasbeenputonholdamidUStariffconcerns.

2WeWork

Oncevaluedat$47billion,WeWork’sbusiness

modelcameunderscrutinybeforeitsfailedIPOin2019,leadingtoasignificantdropinvaluation.

AspartofabailoutpackagefromSoftBank,

WeWork’sexistinginvestorsweregiventheoptiontoeitherselltheirsharesatalowerpriceorreceiveadditionalshareswithanLP,placingthemahead

ofSoftBankintheeventofliquidation.

3Paytm

One97CommunicationsLtd,theparentcompany

ofPaytm,wentpublicin2021witha$20billion

valuation.However,itsstockfellover28%ondebutandlostmorethan75%ofitsvaluebyMarch2022.Since2018,PaytmhasfacedsignificantregulatorychallengesfromtheRBI(ReserveBankofIndia),

intensecompetition,strategicmissteps,

cybersecuritylapsesandregulatorycrackdowns,

especiallyrelatedtoChineseties.Majorinvestors

likeSoftBank,AntGroup,andBerkshireexitedtheirstakes,reflectingdeclininginvestorconfidence.In

H22024,however,Paytmsharesdemonstrated

resilienceandrecoveredover75%duetoimprovingbusinessprospectsandclearanceofregulatory

hurdles,whichboostedinvestorsentimentandconfidenceinitsgrowthpotential.

Thesecasestudiesillustratethecomplexdynamicsofdownroundsanddemonstratehowcompaniescanrecoverfromvaluationslumpsbypivotingtheirbusinessstrategies.

EnforceabilityofLP

Preferredandcommonstockholdersoftenhave

conflictinginterestsinexittransactionsduetoLPs.Preferredshareholdersmightfavorlower-risk,

lower-valuestrategiestosafeguardtheirLPs,whilecommonshareholdersmaypreferhigher-risk,

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higher-valuestrategies.Unlesspreferred

stockholdershavecontractualrightstoforceasaleorputtheirstocktothecompany,mostexitsales

fallundertheboard’sdiscretion.TheBoardof

Directorsowesfiduciarydutiestothecorporation

anditsstockholders,butthesedutiescanvary

basedontheclassofstock.Directorsmustaimto

maximizethecorporation’svalueforitsresidual

claimants,typicallycommonstockholders,rather

thancontractualclaimantslikepreferred

stockholders.Preferredstockrightsarecontractual,anddirectorsdonotowefiduciarydutiesto

preferredstockholderswhenmakingdecisionsthatmightaffecttheircontractualrights.

LPsareusuallypaidinsituationsbeyondthe

board’scontrol,suchasbankruptcy,insolvency,oraforcedsalebyashareholder.Viewedinisolation,apreferredstock’sLPissimilartoaprioritydebt

claimonthefirm.Whenjuniorshareholders

controlthetimingandmodeofanexit,enforcing

LPscanbechallenging,astheymightstructurethetransactiontominimizepayoutstoseniorpreferredshareholders.However,theenforceabilityofLPsisupheldbycontractualagreements,judicial

precedents,fiduciaryduties,regulatoryoversightandpotentiallegalrecourse.Theenforceabilityofexitclausesinshareholders’agreementsiscrucialforinvestorconfidenceandeffectivecorporate

governance.Keymechanisms—including

tag-alongrights,drag-alongrights,andIPO

provisions—requireprecisedraftingtoaddressenforceabilitychallenges,ashighlightedinthefollowingcasestudieswhereinvestors

successfullyexercisedtheirLPs.

1Trados

Foundedin1984,Tradosspecializedindocumenttranslationsoftware.Duringthe2000internet

bubble,itwasvaluedat$14millionandaimedforanIPO.However,post-bubble,itfailedtomeet

investorexpectations.In2005,TradoswassoldtoSDLplcfor$60millionbytheboard.Preferred

shareholdersreceived$52.2millionand

managementgot$7.8millionthrougha

managementincentiveprogram.Preferred

stockholders,witha1.0xLPandan8%cumulativedividend,hadrightsworth

$57.9millionatthetimeofsale,leavingcommon

shareholderswithnothing.MarcChristen,a

commonstockholder,suedtheboardforbreachingfiduciaryduties.Aftereightyears,thecourtruled

thatthesalewasfair,notingthattherewasno

financiallosstocommonshareholdersandno

betteralternativeavailable.However,thecourt

stressedthatboardsshouldgiveprecedencetotheinterestsofcommonstockholdersoverthespecificrightsofpreferredstockholders.

2NineSystems

NineSystemsCorporation,astreamingmedia

company,underwentarecapitalizationin2002,

sharplydilutingcommonstockholderequityfrom

around26%to2%.In2006,NineSystemswassoldtoAkamaiTechnologiesfor$175million.Preferred

VCstockholdersreceivedabout$150million,while

commonstockholdersgotaround$3million.Minorityshareholderschallengedtherecapitalization,allegingtheboardfailedtoobtainanindependentvaluation

andhadnotdisclosedkeyterms.In2014,thecourtfoundthetransactionresultedinafairpricebut

deemedtheprocess“grosslyunfair”duetothelackofindependentvaluationandinadequatedisclosure.

3Instacart

Instacart’sIPOinSeptember2023ledto

substantiallossesforpreferredinvestors.The

company’svaluationplummetedfromabout

$39billioninits2021fundinground(SeriesI)toaround$10billionattheIPO.Consequently,LPsdidnotofferdownsideprotectiontopreferred

shareholdersduringtheIPO,asallshareclasseswereconvertedtocommonsharesandproceedsweredistributedonaproratabasis.

Whenacompanyundergoesadownround,theLPsofpreviousinvestorscanbecomeasignificant

burden.Ifthecompanyissoldatalowervaluationthanthepreviousfundinground,investorswithLPsareentitledtorecouptheirfullinvestmentbefore

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anyothershareholdersreceiveanyproceeds.

Thisscenariocanresultincommonshareholders

receivinglittletonobenefitfromthesale,impactingtheequitypositionsofexistinginvestors,foundersandemployees.Suchsituationscanraiseconcernsaboutbreachesoffiduciarydutiesandtheliability

ofcontrollingshareholders.

ActualValueofLP

Fundsoftenstruggletounderstandhowtheir

preferredinvestments,whichhaveanLPgreater

than1.0xandseniorclaims,couldbevaluedbelowcost,eveninanunderperformingbusiness.

Thisdifficultyarisesmainlybecausetheyplace

significantemphasisondownsideprotection,

overlookingpotentialconflictswithcommon

shareholders,asshowninpreviouscasestudies.ThesecasestudiesalsohighlightthatenforcingLPscanbecomplex,despitetheircontractual

nature,duetoconflictsbetweenpreferredand

commonshareholders.TheBoardofDirectors’

fiduciarydutyistoensurethesaletransactionisentirelyfair,intermsoffairdealingandfairprice,asperstatelawinmajorityoftheUSstates.

Therefore,investorsshouldcorrectlypriceinthevalueofdownsideprotectionattributedtoLPat

thetimeofinvestment.A1.0xLPatentry

combinesvalueascribedtodownsideprotectionandupsidereturns.Forexample:

1.0xLPatEntry=DownsideProtection(about

0.6x)+UpsideReturn(about0.4x)

Ifthecompanyraisesnewfundingthroughadownround,thevalueofthefund’sinvestmentwould

hypotheticallydecreaseto0.8x,ratherthanstayingattheinitialinvestmentcostdespitea1.0xLP.Thisisbecausethevalueattributedtothetwo

componentsoftheLPwouldchangeasfollows:

0.8xFund’sHoldingValueinDownRound=DownsideProtection(about0.7x)+UpsideReturn(about0.1x)

Thus,thevalueofdownsideprotectionincreases

duringadownroundforpreferredshares.Itismorethanoffsetbythedecreaseinvalueattributedto

upsidereturnexpectations,resultinginanet

decreaseintheoverallvalueofthefund’sstake.

Refertothebelowchartforatypicalpayout

structureofnon-participatingconvertible

preferencesharescomparedwiththepayoutofacommonstockinvestorwithoutanyLP.

WaterfallDistributionwithNon-ParticipatingandConvertiblePreferenceShares

>

Liquidation/Exitvalue(in$)

preferredstockInvestorcommonstockInvestor

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AccordingtotheAICPA,thehybridmethod,

whichcombinesscenario-basedmethodsand

theOptionPricingMethod(OPM),canbea

valuablealternativeforsituationswherea

companyhasinsightintooneormorenear-termexitsbutisuncertainabouttheoutcomesif

currentplansdonotmaterialize.TheOPMtreatscommonandpreferredstockascalloptionson

thecompany’sequityvalue,withexercisepricesbasedontheLPsofthepreferredstock.This

methodleveragestheconceptualframeworkof

optionpricingtheorytomodelacontinuous

distributionoffutureoutcomesandcapturetheoption-likepayoffsofvariousshareclasseswhilealsoexplicitlyconsideringfuturescenariosand

thediscontinuitiesthatearly-stagecompanies

oftenface.Duetotheirdownsideprotectionandpriorityclaimonthecompany’sassetsover

commonshareholders,preferredshareholderstypicallyexperienceasmallerdeclineinvaluecomparedtotheoveralldropinthecompany’svaluation.Thisapproachcanbefurther

supportedbyusingahybridmethodtovalueafund’sinvestmentinanearly-stagecompany

withacomplexcapitalstructure.

Fundsoftenincludea1.0xLP,evenifthe

downsideprotectionmightnotholdsignificant

economicvalue.Itisnotinthefund’sbestinteresttoforgonegotiatingthispreferencewhenitis

standardpractice.Early-roundLPstypicallydon’thaveadirecteconomicimpactduetotheneedformultiplefinancingroundstoachievehigh

valuations.Theyensurethatrecentinvestorsholdseniorityandalargershareofthetotalvalue.

Thissenioritygrantstheminfluenceoverfuturefinancingsandexittransactions,particularly

whenthecompanyisunderperforming.

Inessence,LPsbecomecrucialduringlow-to

mid-valueexits.Krollcanassistwithdevelopingvaluationframeworksthatwithstandchallengesandcandocumentsupportablereasonsfor

heightenedconsiderationinthevaluationofdownsideprotection.

Conclusion

Overall,in2024,thestartupfinancinglandscapeshiftedtowardlowervaluationsduetohigh

valuationmultiplesandliquidityneeds.Companiesfacingliquidityissuesareoftendriveninto

downrounds,whichaffectequitystakesandrequirethenegotiationofLPstoprotectinvestors.However,enforcingLPsiscomplex,asenforcementisinfluencedbytheconflictinginterestsofpreferredandcommonstockholders.Preferredshareholderstypicallyseeklower-riskstrategies,whilecommonshareholdersmayfavorhigher-riskapproaches.TheBoardofDirectorsmust

prioritizetheinterestsofcommonstockholders.Althoughchallenging,enforcingLPsis

supportedbycontractualagreements,judicialprecedents,andregulatoryoversight.Realworldexamples,suchasTradosandNineSystems,highlighttheimportanceoffairdealingandthe

truevalueofLPs.Utilizingvaluationmethodslikethehybridmethodcanfurtheraidinassessinginvestmentsinearly-stagecompanieswithcomplexcapitalstructures.

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Contacts

StevenNebb

ManagingDirector,PortfolioValuation/p>

steven.nebb@

StevenNebb,CFAisamanagingdirectorandservesastheprojectleadfornumerousAlternativeAssetmanagersandinvestors,includinglargeglobalprivateequity,venturecapital,andBusinessDevelopmentCompanies.Heprovidesadvisorysupporttomanylimitedpartnershipsandcorporatepensionplansregardingfundmanagement,financialreportingrequirementsandgeneralvaluationofinvestments,andhasover20yearsofexperienceinperformingvaluationsofintellectualpr