Why participating preferences maybe absurd and how 409A valuations can consider this absurdity?

Imagine a term sheet where your pre-money valuation is $25million and you raised $5 million. The post money valuation therefore is $30 million and the VCs share of the company is 5/30 or 16.7%. Now, the liquidation preference (typically at 1X the investment dollars or issue price) would be $5 million and let us say the VC wants another 1X in participating preference. One of the interesting things to note is that the $30 million valuation is almost 6 times the liquidation preference ($5MM) and 3 times the participating preference ($10MM) thresholds. When analyzing the waterfall model, it can be shown that the full per share issue price of the VCs stock is reached when the valuation equals or just crosses the liquidation preference amount. Anything beyond this is a value that accrues to the preferred share price until the participating cap is reached at $10 million valuation. Given that the valuation right on the day of investment is $30 million, the VCs would have made money on their stock on the day of investment, and then some, as the valuation would have crossed even the preferred participating threshold. And, if the issue price is set in a certain way that the VCs would find it in their interests to convert to common stock, then even more money would accrue to the per share price of the VCs, right on the day of investment. Note that this money is only on paper and no worthwhile progress toward creating or meeting milestones has been made by the target company. The valuation conundrum leads to the creation of artificial wealth. Whew, talk about magic money.
On the other hand if the valuation was just restricted to the liquidation or participating preference caps, then the VCs would end up owning all the shares in the company - a non-viable proposition as well.
This is one of the reasons we do not take VCs post money valuation as the sole indicator in 409A valuations. We even go as far as to term this "investment value" - a notation that can be given less weight under 409A valuations, or some times, depending upon the investment conditions, completely ignored.

The Age of App Platforms

Internet businesses seem to set new management paradigms than their offline counterparts. Revenues are earned by sharing them with each other and costs are apportioned between competitors in innovative ways through clever use of hardware and software solutions. An important way of doing business currently is the App Platform. The App platforms are application servers that companies such as SalesForce.com, FaceBook, Apple, Amazon.com and others make available to people who want to target their audiences not through their products and services but through their own applications. App developers have a variety of business models to monetize including sharing application download fees with app platform providers and supplying advertising revenues and traffic. If you are a start-up seeking to build a large subscriber based business, then app platforms are a MUST as a component, if you wish to see better valuations for your business. Just as with other businesses, there are certain Internet-based businesses such as retailing where revenues may become stagnant in the new American "savings" era. Innovative revenue sharing and growth models may become a necessity now.