With stock markets hitting all-time highs in 2017, there has been an increase in the number of highly-valued tech start-ups going public.
Four Unicorns, private companies valued at $1 billion or higher, completed initial public offerings (IPOs) in the second quarter 2017. That was double what was seen in the first quarter and equal to the number of Unicorn IPOs for the entire year in both 2015 and 2016, according to data compiled by Goldman Sachs.
Research from Play Bigger, a Silicon Valley consultancy that works with VC-backed start-ups, confirms that Unicorns are growing faster in recent years. Should investors be looking to jump on the bandwagon?
Eight years ago there was no Uber. Six years ago Uber only operated in San Francisco. Today it offers rides in more than 84 countries and 737 cities worldwide, is reported to have raised over $11.5 billion and is valued at approximately $68 billion.
Whilst impressive and even with Uber’s recent travails, there are predictions a valuation of over $100 billion could be achieved by 2020, we look at how such a valuation is possible and also whether it is sustainable.
The Valuation Business
There are a number of metrics used to estimate what a business might be worth; such as multiples of revenue or profit, discounted cash flow, industry comparables etc. The aim is to calculate a fair valuation of the business. None of these are used to determine the value of Unicorns.
Start-ups are hitting billion dollar valuations in less than three years, which is quite a rate of growth. To persuade investors, you are the next Unicorn in the making you need to:
- Write an overly ambitious and (almost certainly) unachievable business plan
To create immense shareholder value and/or build a transformative, global company in the fastest time possible, the business plan will need to predict 15% week over week growth. To execute such a plan, said start-up will need to hire the best talent available, secure a staggering array of customers or users to demonstrate exponential growth on the way to world domination.
- Attract investment at a sky high valuation
Investors come in at a valuation based upon where the company will be assuming they flawlessly follow their over ambitious and (almost certainly) unachievable business plan.
In April 2006, Facebook was the trailblazer, raising $27.5 million at a valuation of $500m.
Uber raised $37 million in 2011 at a valuation of $300 million.
Both of these rounds were two years after being established.
- Deliver on The Promise
Now, the tricky bit. Having accepted investor money at a sky high valuation, the Company has to demonstrate they are at least achieving part of their over ambitious business plan. They will need to hire even more of the best talent available, chase market share aggressively and hope that their chosen market is growing very fast.
If the management team does manage to offer sufficient evidence to defend their overly ambitious growth plan, they can then look to attract further investment at an even higher valuation. The modern day Unicorn has successfully repeated the above cycle until they hit the billion dollar valuation.
In March 2008, Facebook raised $60m at a valuation of $14.7 billion.
In June 2014, Uber raised $1.4 billion at a valuation of $17 billion.
On reading this, many will quite rightly point out that both Facebook and Uber went on to achieve significantly higher valuations. This is because they have both managed to repeatedly deliver on The Promise stage. For the many wannabe Unicorns, not everyone can employ the best talent out there and subsequently they made one promise too many. Remember Groupon, Njoy and Theranos?
Critics say that a Unicorn’s valuation is often based upon a group of investors believing (and more importantly wanting others to believe) the Company is worth that amount. They go further, stating such valuations do not reflect actual value but are inflated by intricate rounds of financing.
The strategy has worked for the 267 Unicorns with a collective valuation of over $920 billion (Techcrunch Crunchbase September 2017). At the same time, there are many that have failed along the way as well as a number of Unicorns that have subsequently come unstuck.
The big question is whether it is worth investors chasing Unicorns or focusing on technology businesses with more sustainable growth plans taking advantage of the opportunities created by the trailblazers. We know what we prefer and we will endeavour to keep opening up this market for private investors.
The information in this website is provided by CSS Partners LLP. This website has been approved for the purposes of section 21 of the Financial Services and Markets Act by Charles Street Securities Europe LLP (CSSE), which is authorised and regulated by the Financial Conduct Authority. CSS Partners is an appointed representative of CSSE.
Any views or opinions expressed in this blog are those of the author alone, except where specifically stated that they are the views of CSS Partners LLP.