The trending buzz word in venture capital over the last few years has been unicorn. Investopedia defines unicorn as, “a company, usually a start-up that does not have an established performance record, with a stock market valuation or estimated valuation of more than $1 billion.” Examples of unicorns cover the “who’s who” of tech startups, from Uber to Airbnb.
Square, Inc., a mobile payment processing company founded by twitter co-founder Jack Dorsey, recently shook up the unicorn world when they went public at a lower valuation than their last round of private funding. The Square IPO is just another example of how (what many not drinking the Silicon Valley kool-aid have thinking/saying) extreme private valuations don’t translate into traditional value.
The majority of unicorns are not profitable and thus need to constantly raise capital. Not only do unicorns constantly raise capital, but they are pressured to raise each subsequent round at a higher valuation than the last. As valuations climb to extremes ($10 billion +) it becomes harder and harder for unicorns to raise capital at higher valuations than previous rounds.
Unicorns eventually have four options; (1) run out of cash, (2) raise funding at a lower valuation, (3) sell, or (4) go public. For the majority of unicorns all of these prospects can be very scary! The first option, running out of cash, is just a nice way of saying going out of business. Shutting down is probably not the preferred option for any unicorn’s leadership team and shareholders. That leaves unicorns with three choices; (1) raise capital at a lower valuation, (2) sell, or (3) go public. All three of those options usually mean accepting a lower valuation than previous rounds. The lack of options is the primary reason many high-profile unicorn investors are beginning to “write down” the value of their unicorn holdings.
So , why is it that all paths out of Silicon Valley, for unicorns, lead to lower valuations? Let’s breakdown each option individually.
(1) First option is to continue raising capital as a private company. As the excitement fades and best case expectations are replaced with reality, it becomes harder to convince big money investors to value what is essentially a “start-up” equal to traditional billion dollar companies.
(2) Option two is to sell. The problem is, there aren’t many companies with the ability or appetite to purchase multi billion dollar startups! Most multi-billion dollar M&A transactions are of successful target businesses with billions in assets, revenues, and profits that allow acquirers to leverage a target’s financial strengths to finance the deal(s). While there may be some acquirers with the ability to make $10 billion+ acquisitions, without outside financing, they are often public and can’t justify spending billions of shareholder’s capital to acquire what is essentially a start-up.
(3) The last option is to go public. Many unicorns (Square, FitBit, GoPro, etc.) have chosen this path and have struggled in the market. Most recently Square priced its IPO below the expected price range (although it seems to have recovered for now). FitBit and GoPro stock have both been roller- coaster rides for investors. While Square, GoPro, and FitBit still have the opportunity to prove themselves to the market, perhaps we can look at companies of the dot-com bubble for clues of what might become of today’s unicorns.
While the journey out of Silicon Valley is a difficult one for unicorns, don’t feel too bad for them because they are still unicorns or “wild, un-tamable animals of great strength and agility”!
For more on the “Unicorn Bubble” check out these links:
Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisition funding. He has extensive experience with both private and public companies. Ben graduated with an economics degree from Bentley University where he concentrated in entrepreneurship and law.