The latest Silicon Valley head scratcher: How can Uber, one of the most sought-after startup investments, sell shares at two separate valuations?
Short answer: because it can.
Slightly longer answer: because it’s selling on a secret marketplace, and you can distort almost anything when fewer people are subject to the deal.
But who’s losing and who’s winning here?
First, the context: Uber has become all too familiar with misdeeds and misbehaviors, as it weathers multiple scandals and lawsuits.
The ride-hail giant also needs money — it loses more than $2 billion a year.
At the same time, it’s also growing, about doubling its sales, which is why SoftBank’s Masayoshi Son is willing to pay as much as $10 billion for a significant stake, and say, in the company.
He’s agreed, in principle, to buy two different kinds of shares: one set sold by existing investors in what’s known as a tender offer, and another set of new shares issued by Uber.
For the first set, Son has offered a valuation of about $50 billion. For the second, he’s willing to buy them at the current company valuation of $68 billion.
SoftBank would be buying both at a discount and at market price.
And as odd as that sounds, it’s not entirely unusual. Technically, Uber is selling two different type of shares with different rights.
(If you follow the fixed income market, or the securities market there’s a similar level of opacity and arbitrage, which is a big reason why the sub-prime mortgage crisis happened.)
But what’s really interesting here is that Son is taking advantage of Uber’s opacity. The fact that it “trades” in a private, or a secret marketplace is what allows him to exploit the lack of liquidity, or the investors’ inability to sell their shares.
In an open market, like the New York Stock Exchange, an investor can sell shares almost any time, without the need for lengthy negotiations.
There are brokers and screens all around the world advertising the going rate for shares, and the investor can take advantage of this built-in mechanism as soon as shares hit the right price.
In a VC-backed startup like Uber, there isn’t an open trading system. It’s a closed system — on purpose. That’s so investors can control the company’s valuation, which they do by deciding de jure what a company is worth.
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Valuations are done by fiat — it is what they say.
Of course, where that bites them is when a company becomes so riddled by scandal and mismanagement that anyone who wants to get out, can’t. Or they have to sell at a lower valuation as is potentially the case here.
Another way to look at SoftBank’s offer: it’s a “down round,” since Son would be pumping $10 billion into a company whose overall valuation remains the same.
To be clear, the investors who do plan to sell their shares aren’t necessarily losing.
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They’ll still realize a profit, but at a lower amount than what they would get in an IPO.
And that, of course, is the endgame. As much as Silicon Valley founders like to operate solely by the light of their own egos, they’ve made a bargain with investors to give them a return, and that usually comes with an exit, like a sale on the public markets, or an outright acquisition.
At a $68 billion valuation with losses in the billions, it’s unlikely anyone would, or could acquire it.
Uber’s new CEO, Dara Khosrowshahi, knows this, of course, which means he’ll likely want to get to IPO as soon as possible.
This article originally appeared on Recode.net.