We’ve got to stop calling them valuations

Why Uber isn’t worth $62.5 billion.

Uber’s recent financing round apparently valued the company at $62.5 billion, more than Ford and GM combined. With a headline like that, it might be natural for employees and early investors to start browsing the option packages on the Maserati website. But they shouldn’t.

Headlines such as the one used by Bloomberg overstate the value of the company being financed because they misunderstand what’s being bought and sold. Uber isn’t actually worth $62.5 billion. At least, not according to the most recent investors.

Here’s why. What’s being sold in most late-stage financing rounds isn’t really equity. Sure, it’s called “preferred stock” but despite its name, it’s most accurately termed a type of debt.

A little finance 101: Debt holders are promised a fixed rate of return and get paid before everyone else. Minor upside, minor downside. Holders of equity (or common stock) get what’s left after everyone else has been paid. Major upside, but also major downside.

So what about preferred stockholders? They get a guaranteed return, just like with debt (except it’s called a liquidation preference instead of interest). They’re also paid out before common stockholders. Again, just like debt. However, unlike debt, if the company’s valuation skyrockets then preferred stockholders get the same upside as equity.

To recap, preferred stockholders get unlimited upside with minor potential for downside. Truly the best of both worlds.

When a company comes to IPO, it sells common stock, not preferred stock. With no downside protection, common stock is less valuable than the preferred stock sold in late stage private rounds. So it’s no surprise that IPO valuations are less than a private valuations, because they’re not valuing the same things at all.

So when Uber raises money “at a $62.5 valuation” it doesn’t mean that the common stock of Uber is worth $62.5 billion. In fact, it’s a strong signal that Uber is worth less than $62.5 billion. Because investors bought preferred stock, which is objectively better than common stock, the value of all common stock must be lower than $62.5 billion.

Using the nominal value of preference shares to discuss the underlying value of a private company is highly misleading to employees, investors, and the public at large. We should all stop doing it.