Fidelity Devalues Stake in Blue Bottle, Dataminr, Zenefits Following Snapchat

Hypothetical situation with some seriously made-up numbers:

* 2x $100k for 5% investment in companies at say a diluted stake of 2% goes from $10B to 5B

* 5x $100k for 5% investment in companies who go bust

* 3x $100k for 5% investment in companies who are acquired, make 10% returns ($110k per).

Total investment: $1m

Return from non-outliers: (5 x $0) + (3 x $110k) => $330k for a net of -$570k

Return from outliers before devaluation (on paper): 2 x .02 x $10B => $400M

Return from outliers after devaluation (on paper): 2 x .02 x $5B => $200M

At this point, the losses/returns of the non-outliers are in the noise. But man, it hurts to have to explain the "loss" of your upside by such an enormous amount. I don't think VCs would shrug it off as just a part of their overall portfolio, since these are the valuations that prop up the overall performance.

Employees (and Founders) have common stock, while Investors get preferred stock.

Preferred stock carries with it a "liquidation preference", which basically means holders of that stock get paid out first during a liquidity event, including some multiple of their original investment. What ever is left, is divided among the holders of common stock.

If the company is publicly traded, then all owners of stock hold the same class of stock (common).

However, that can only happen so many times before the "suckers" that were buying these things at IPO catch on and lose their appetite. That sort of thing is in part what's happening and in part why these write downs are occurring. The paper valuation during funding rounds is only real if the "real market" (i.e. everyone, not just a few VCs writing founders a cheque) is willing to buy shares at that value. If the market continues to get more skeptical, and there's every indication that this will continue to be the case, then down rounds are an almost certainty moving forward for many firms.

That's also a big problem for employee options, which typically only have value if the valuation keeps skyrocketing.

But, I still wouldn't worry about that too much directly. As the article mentions, it's more art than science. If I were Zenefits I don't think I'd be sweating it.

Some skepticism from investors is good, more due diligence re: valuation is good. This is a pretty mild correction overall, which is good for everyone.

I'd be much more worried if Fidelity were snapping up startup shares at ever-higher valuations without ever reckoning actual performance.

As people who work in the industry, this might mean a mild slowdown in hiring as funding becomes a bit more difficult, but it also may prevent the catastrophic alternative which is the bottom falling out from under us and massive tech-sector unemployment.

Personally I think all of these recent announcements are good for startup employees. For the last few years some of us have been expressing a lot of skepticism about the real value of startup options and how much they can realistically exit for. Between valuation write-downs like this, and the face-plant IPOs of the last couple of years, I think people are starting to see the true value of startup options and I hope it results in people being much more discerning about how they're being compensated.

If you take equity, you are not only subject to dilutions, but also to other investors getting much more preferential terms to you.

I'm not saying to don't take a job because of shares, RSUs, or options offered, but one needs to take a hard look at these things to figure out what their true worth is. And in most cases, you may only be able to compute a confidence interval and not a point estimate.

Fidelity's disclosure makes this seemingly intractable problem a bit less intractable.