The Billion Dollar Startup Club has 101 companies as of July 2015, with the number one private company valued at $46 billion. It’s no secret. Technology has revolutionized entrepreneurship. The explosive growth of tech-based companies is at its highest since 1995, surpassing the dot-com boom of year 2000.
In a press release covering the annual MoneyTree report, the National Venture Capital Association (NVCA) stated, “Dollars going into Software companies accounted for 41 percent of total venture capital investments in 2014, the highest percentage since the inception of the MoneyTree Report in 1995.”
With almost half of venture capital being allocated to software startups, there is a concern looming around a dot-com bubble relapse. But companies such as Facebook and Google, built solely as websites, disprove the idea that an Internet company is merely a fad.
Rather, we see an increase in software and web-based companies creating new industries and disjointing others, capturing enormous valuations. This trend has led to the emergence of the term “Unicorn” to describe these companies, which we will examine in depth below.
The definition of “Unicorn” is a venture-backed, private equity technology company valued at a billion dollars or more.
Why the Word “Unicorn”?
In the tech startup industry, a billion dollar valuation was a fleeting, mythological belief with just enough realism to look for it – just like the dazzling horned steed of rainbow lore. The odds of creating a billion dollar valuation were about as realistic as the existence of a unicorn. While we may not see the creature very often, we read about tech startup unicorns more and more every day in headlines.
A new buzzword, “decacorn,” is now used for companies valued over $10 billion, which includes companies such as Airbnb, Dropbox, Pinterest, Snapchat, and Uber.
In order to receive a “billion dollar valuation,” a company must fundraise from investors. When investors hear a pitch from entrepreneurs, they want to hear the percentage of ownership in the company they can buy. This ownership is also called equity.
For example, if a startup team approaches an investor and says, “We will give you 10% of our company in return for $25 million.” This means that the startup team believes their company is worth $250 million and they are willing to give the investor 10 percent of equity.
Why would this be appealing to the investor?
Because the investor is counting on the fact that in a year or two, the startup will be worth close to $1 billion, which would make the investor’s 10 percent worth $250 million — a healthy 10x return on his investment.
So for a tech startup to enter the Billion Dollar Unicorn Club, the investors have to invest a sum of money for a percentage of the company where the logical 100 percent equals a billion dollars or more.
“Private equity” means it is not a publicly-traded company. In other words, a private equity company cannot be invested in without explicit invitation and customized terms. On the other hand, a public equity company is listed on the New York Stock Exchange (NYSE) or Nasdaq for anyone to purchase shares. Many of these public companies have valuations far beyond a billion dollars. For example, at the time of this writing, Apple is the most valued company in the world at $746.74 billion; Google is valued at $672.93 billion. Does this make them unicorns? No, because they are not private equity companies.
Why does a unicorn have to be a technology company? This is a good question because there are 230+ private companies with billion dollar plus valuations such as food processing giant Cargill ($134.90B in Revenue), Koch Industries ($115.00B in Revenue), and Dell ($57.20B). Are these not considered unicorns?
Yes, they’re not. For several reasons:
- They are not startup companies; they are large, established global business operations with hundreds and even thousands of employees.
- Their valuations are not based on venture capital or fundraising. Rather, they have significant revenue streams so instead of a “valuation” we would rather use a capitalization rate to value the company.
Additionally, these large private companies are not considered unicorns because many of them are involved in the food and drink industry, gas and oil industry, or automotive industry — not technology. Why does it matter that a startup is in the technology industry?
Many Investors prefer tech deals because a web-based, software company can scale amazingly quickly. Uber, a technology platform that connects riders and drivers, launched in 2010 is now worth $50 billion. Compare that to household brands such as toy company Mattel (worth $8.23B) founded in 1945 and Whole Foods Market (worth $14.92B) founded in 1980. Investors love tech because of the get-in-get-out opportunity it provides in less than a handful of years.
A Billion Dollars
Actually, the massive valuations that these tech startups are receiving are somewhat made up. In a Bloomberg Business article entitled The Fuzzy, Insane Math That’s Creating So Many Billion-Dollar Tech Companies, the author wrote that the calculation is based on subjective variables such as the founders hopes, investor self-protection, and competitor comparison. There are many other rationalizations for setting exorbitant valuations including the size of the user base (paying or not paying), press coverage, and growth projections.
In the end, the regulation and legal procedures of an IPO can deflate the unicorn valuation bubble to a more realistic number, sometimes even up to 30 or 50 percent, said Barry Kramer, a partner at Fenwick & West, a law firm involved in some of the Valley’s hottest deals. But why would a company file publicly if it can raise $1.5 billion in private investment?
If you have any questions about private equity, venture capital, or valuations, we are here to help. Reach out to Funding Sage on Twitter and ask us anything.