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Startups eager for sky-high valuations should heed this cautionary tale
As the IPO market tanks and startups continue to seek absurdly high valuations, they would do well to remember the 2013 listing of textbook rental service Chegg and its ill-fated use of the IPO "ratchet."
Wall Street Journal's Venture Capital Dispatch recalls how Chegg sought to secure a higher valuation during its pre-IPO funding rounds by promising investors their share price would double by time the company went public – a term known as a "ratchet." It backfired. Massively. As early Chegg investor Oren Zeev explained in a conference this year:
“While it turned out that the top line was great, the fundamentals of the business, or the assumptions we were making about the business, were a stretch. It was far less clear it was a great business.”
The upshot was that the business sunk below its IPO valuation after going public and could not deliver on what it promised, and Chegg was forced to issue additional shares to Insight Venture Partners, the VC with which it had the covenant. Companies like Box Inc. and Kayak Software Corp. have also had to pay a painful price for the same reason.
One has to wonder how many of our newly-born unicorns managed to achieve such lofty valuations, and how they will cope when it's time to go public.