stockI have got an offer from a very hot late stage startup that I think will go public no later than 2016. They have offered me X RSUs and I was told the preferred stock price of last round of funding which happened not long ago. Is it reasonable to use that number as the target IPO price?
EDIT: I did some research and found some articles that disclosed the preferred stock price of previous rounds of funding this company had done. That price is actually greater than the preferred stock price in latest round of funding. That is baffling to me. I thought if the company valuation is going up, the preferred stock price should go up, but clearly it doesn’t have to be that way. Why?
Also I thought if some investors have paid X to get the shares, they wouldn’t let an IPO happen below X, but clearly that also does not seem to be the case. Why? At time of IPO my understanding is that preferred stock gets converted into common stock. Is there a multiplier associated so that 1 preferred stock gets converted into 10 shares of common stock - that would be one way that would explain above.
EDIT 2: so my conjecture was true. see this
Is the preferred stock price a reasonable indicator of IPO share price for a late stage startup?
Absolutely not. Common share prices are driven by supply and demand, not some absolute measure like the face value of individual preferred shares at some given point in time. You can however use the price of a preferred stock to infer a valuation for the company (after removing the debt component and any other special features).
I have got an offer from a very hot late stage startup that I think will go public no later than 2016. They have offered me X RSUs and I was told the preferred stock price of last round of funding which happened not long ago. Is it reasonable to use that number as the target IPO price?
No. The IPO price will be based on the supply of and demand for the common shares floated. Again, individual stock prices cannot be viewed in absolute terms. The price of a stock depends on how many shares there are and how much demand there is for those shares. You can value a stock in a million ways, some smart and some not-so-smart, but at the end of the day what matters is what the market decides.
EDIT: I did some research and found some articles that disclosed the preferred stock price of previous rounds of funding this company had done. That price is actually greater than the preferred stock price in latest round of funding. That is baffling to me. I thought if the company valuation is going up, the preferred stock price should go up, but clearly it doesn't have to be that way. Why?
Comparing different rounds in such a simplistic way is comparing apples-to-oranges. You need to stop looking at share prices and start looking at the value of the company the shares imply. In the most elementary terms, [common shares outstanding x share price per share = company valuation]. (There are many other things to consider as well.)
Also I thought if some investors have paid X to get the shares, they wouldn't let an IPO happen below X, but clearly that also does not seem to be the case. Why?
While it is true that having infinite money, any investor can manipulate the price of a stock to any degree he wants, investors would be foolish to blow good capital to set an artificial floor on the value of a company. At each pre-IPO round, the shareholders are given the opportunity to invest more to maintain their current percentage ownership. They can choose to exercise this option and invest more or they can choose to keep what they have and let the values of their shares dilute. The IPO will be priced based on the demand an investment bank finds for the shares. Now, the pre-IPO investors can decide to back out of the IPO if they feel the market is not providing enough and they can "lock-in" the idea of an artificial share value based on the most previous funding round -- but this does not reflect the true value of the shares they hold. What matters is always how much people are willing to pay for the full quantity of shares you want to sell in an IPO.
At time of IPO my understanding is that preferred stock gets converted into common stock. Is there a multiplier associated so that 1 preferred stock gets converted into 10 shares of common stock - that would be one way that would explain above.
This all depends on the terms of the preferred shares. There are no hard rules though there are standards. Convertible shares by definition have to have a conversion ratio. They don't necessarily have to convert at the time of an IPO.
You might want to consider hiring a financial analyst to evaluate the offer before making any investment decision. Anyone with the letters "CFA" after their name would be able to help you.
The price of stocks during funding rounds and at an IPO and later on the stock market depends on what people think the company is worth. The value of a company can therefore change in both positive or negative direction depending on the performance. I.e. if company X wants to launch a great new product in December 2016, but then finds some problems with the product and the launch has to be postponed to 2017, this will negatively impact the value of the company no matter whether it is before, at or after an IPO.
An IPO below funding value is absolutely possible:
http://fortune.com/2015/11/06/square-valuation-ipo/
If you and other investors pay 40$ per share before an IPO and the company struggles and is only worth 30$ per share now, investors will still accept an IPO at 30$ per share because it is what the company is worth. The investors are not loosing the money because of the IPO, they are loosing money because the company struggles and their investment was not as good as they hoped.
In light of this link, the preferred stock price in combination with the conversion ratio provides a solid lower bound on the IPO price. The investors won’t let an IPO happen below that price, else they would be losing money on their investment.
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