A Goldilocks Market For Unicorns?

Guest Post by Sven Weber-SharesPost

There’s been much hand-wringing about whether the venture capital community is producing an unusually high number of unicorns and is creating a bubble, but is the worry justified?

The answer is “no” if you compare the number of successful start-ups being minted by the venture capital community today to the historical average. That’s one of a handful of key findings from SharesPost’s newest white paper about the innovation economy and unicorns.

Unicorns and Home Runs
To validate that assertion, it’s important to first define the terrain. Prior to the “unicorn” moniker of the past few years, the venture capital industry defined success in terms of “VC batting averages” and “home runs.”

Historically, venture capitalists deployed their capital with an investment strategy betting on a batting average of 1%-2% of “home runs.” That is, for every 100 venture capital backed start-ups, 1 to 2 companies becomes a “home run,” which is defined by its outsized returns.

Because there are many unicorns and they are a relatively new phenomenon, they also tend to get outsized visibility and feed the perception that we may be in a bubble. But the numbers on the batting average of recent years tell a different story.

sp

With the exception of the dot-com bubble, the batting average on unicorns is consistent with the historic VC batting average of 1% to 2% for homeruns. In other words, venture capitalists are doing what they’ve done for decades – produce 1 to 2 homeruns for every 100 companies they fund. The big difference is that these homeruns are staying private today instead of going public.

Timing of Unicorns Coincides with past IPO timing
Interestingly, one of the findings of the research shows that the median time to “produce” a unicorn in the US today is 76 months. This means for 50% of today’s unicorns, it took about 6 to 7 years for a company to reach a $1B valuation.

It’s no coincidence that this length of time is about how long it took in the past for a company to go IPO. Historically, the time to an IPO was 6 to 8 years whereas today it is 9 to 11 years.

Both the batting average and the timing of unicorn production show that venture capitalists are producing home runs at a normal rate. There seems to be no over-production of successful VC backed companies.

A Higher Multiple
A key question is why VC home runs today seem to be much more substantial than they have been in the past. In other words, why are the valuations so high?

This answer is exceptional growth, combined with the private market.

The private market allows firms to grow significantly larger than before an IPO. When Apple had its IPO it was 5½-years-old, it had $114 million in revenue and grew 145% per year. Today, a company with this profile stays private.

To that point about growth, SharesPost’s research found that the aggregate market cap of unicorns grew more than 500% since 2014. That’s enormous. Companies didn’t enjoy that kind of growth rate before the private market because they were pushed to get an IPO to both finance their growth and to provide liquidity to its employees and investors.

It’s no wonder private market companies are staying private today: Private growth companies can secure all the capital and liquidity they need, while achieving phenomenal revenue growth and enterprise value without enduring the challenges of being a young, publicly traded company. One misstep in quarterly earnings can be disastrous. In February, LinkedIn lost 40% of its value – $11 billion in one day when it missed earnings.

VC, Founders In Synch
Interestingly, the desire to remain private has created a new alignment between VCs and entrepreneur founders.

For the first time, their interests are in synch. VC-funded tech firms can get liquidity for themselves, employees and angel investors through the rapidly expanding secondary markets. In addition, a later exit drives to higher valuation and higher valuations drive the return multiples for venture capitalists.

Today VCs can harvest a higher multiple on their home runs than ever before in the history of venture capital. During the first decade of the 21st century, VC returns have been less than attractive and many people predicted the end of venture capital. The new private growth market generates today a win-win: Founders can achieve liquidity and VCs can make the math work for their returns.

When emotions run high, one of the first casualties is rational analysis. We’ve always liked numbers, and these numbers tell an entirely different story than what many are others are saying.

Sven Weber is a Managing Director of SharesPost’s SEC-registered investment advisor, SharesPost Investments Management, LLC. He is responsible for the management of the SharesPost investment vehicles. Sven is also the President and a Trustee of the SharesPost 100 Fund.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s