[jonshea]

I largely agree with dhh’s thesis that “minority investment valuations aren’t real”, and I agree that the lack of liquidity is part of the problem. But I think it’s “liquidity preference” that totally breaks the investor valuation.

As a toy example, imagine a company that could be worth $3, $30, or $300 each with equal probability. The logical valuation of this company is $111. A risk tolerant investor would pay $11.1 for 10% of the company.

Now imagine you have a 3x liquidation preference. If the company liquidates for less than 3 times your investment, then you get it all and the suckers holding common stock get nothing. How much will you pay for 10% of the company in this situation?

Well, if the company exits at $3 or $30 then you’ll get all of it, and if it exits at $300 then you get $30. The total expected value is ($3 + $30 + $30)/3 = $21. That’s almost twice what you’d pay if didn’t have liquidity preference! Even though, with 3x liquidity preference, you’d pay $21 for 10% of the company, $210 is clearly a nonsense valuation for the company as a whole.