A report from the Stanford Graduate School of Business has concluded that the “Unicorns” of Silicon Valley are massively overvalued:

Unicorns were once considered rare. Now, the United States is home to more than 100 of these venture-backed companies, each worth more than $1 billion.

But are these magical beasts really dressed-up ponies? New research from Stanford Graduate School of Business Professor Ilya Strebulaev shows that these companies report values on average about 51% above what they are really worth. And some, including management software company Compass and financial technology company Kabbage, are more than 100% above fair market value.

The Black Box of Market Value
Determining a startup’s worth can be a challenge. Many are fast-growing and unprofitable, and almost all have complex financial structures. They raise funding in multiple rounds, offering investors different restrictions and protections, and therefore stock pricing. The average unicorn, the researchers note, has eight stock classes for different types of investors, including founders, employees, venture capitalists, mutual funds, and others.

Because of that complicated structure, valuation is often based on the latest series’ price, applied to all outstanding shares.

But that doesn’t accurately reflect the preferred treatment some investors might get, the researchers say. In some series, for example, investors are promised 1.5 to 2 times their money should an initial public offering (IPO) fizzle. In that case, other shares can be worth far less.

“Some unicorns have made such generous promises to their preferred shareholders that their common shares are nearly worthless,” the researchers note.

We need to tighten up on securities fraud laws.