Unicorns are all around us. No longer just mythical creatures from fairy tales, these companies which have been valued at at least $1B at some point in their history and are a sizable number of the apps you use on a daily basis, like Uber, Airbnb, or Snapchat, just to name a few. The United States is home to over 100 of these types of companies. There’s even the “decacorn” variant, ringing in at a $10B valuation and beyond. But with all that excitement in the marketplace, are these companies actually good for business?
The Problem of Valuation
The problem is that valuation doesn’t tell you anything about a business. All it can tell you is what the most recent investor paid, applied to all outstanding shares. At the end of the day, a valuation is simply a good guess. It’s a guess signed off on by professional investors, often venture capitalists, who are people who have made fortunes (often more than once) from good guesses, but it’s still a guess. Worse, the prevailing market strategy (for VC money in general, but especially in regards to tech) is to get a company to go public as quickly as is viable rather than focusing on long-term fundamentals or sustainability.
The average unicorn has eight stock classes for different types of investors, which can include founders, employees, VCs, and others. These different classes have different rights, which may include veto rights to prevent an IPO priced below the last private valuation, or IPO rachets, which give certain investors more shares in case the IPO disappoints. These different stock classes and conditions mean that when the latest series of funding occurs, and that share price is applied to all outstanding shares, that there’s likely a major discrepancy in valuation.
The Bigger Problem of Overvaluation
Suspicions of overvaluation among unicorns was highlighted in a study last year which was run jointly by the Stanford Business School and the University of British Columbia on behalf of the National Bureau of Economic Research. The study found, using modeling which took into account various term sheets offered by these startups at different stages of funding, that the average unicorn was valued at 50% above its real value, and that some were over 100% overvalued.
The most high profile examples of those moderately overvalued included Airbnb, which was given a 13% discount off its valuation by the study, as well as Uber (11%), and Buzzfeed (37%). Some big losers in the study were financial startup Kabbage, considered to be overvalued by 138%, as well as payment processor Square (171%) and Elon Musk’s SolarCity (188%).
A Sustainable Future when the Bubble Pops
It’s true that many companies develop so quickly that they get acquired just as they are starting to make a name for themselves. Examples include Whatsapp, Instagram, and Oculus, all acquired by Facebook, and Motorola and Nest, acquired by Google. Companies with a lot of cash who have every incentive and desire to “own everything tech” would much rather co-opt innovation than wait-and-see. And their investors feel the same way. And some founders of these unicorns admittedly are racing towards acquisition. A long-term business model isn’t their largest concern if they can catch the eye of one of the tech giants who can fold the service or product into their core offerings and make the cost of the product simply a line item on financial statements that span the globe.
But as fast as technology changes (and we are no stranger to that, as VocaWorks is very much leading the charge in our space of connecting vetted staff with engaged employers) business fundamentals don’t change. While “disruption” can be exciting, what matters is quality, sustainable growth, and a company ethos that sees win/win whenever possible. A company can be focused on those strengths and be a unicorn but the fallout from a bubble popping won’t just affect VCs and these unicorns, but all companies in the marketplace.
Unicorns can get the marketplace excited and get investors tapping calculators, but valuations should not be the measure of all things. The chance to lead lies at the top of both these unicorn companies and the decision makers at the VC firms. They can choose to tie funding to more reasonable levels – not just “what the market will bear” but “what makes financial sense” – as well as decrease the number of special terms attached to funding rounds so that if and when the company goes public, employees aren’t left holding an empty bag of shares. Leaders have to lead not just when everyone is watching, but especially when no one is, and unless better leadership can be shown in Silicon Valley and elsewhere, there may be dead unicorns in our near future, which will lead to serious consequences for everyone.
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Stephen writes about startups, hiring and career issues for VocaWorks.