The rise of unicorns: a funding event, not a destination

Paul Asel, NGP Capital

On Oct. 9, when Brex announced its $125 million Series C financing, Business Insider proclaimed breathlessly, “credit card startup joins unicorn club months after launching.”

Since the term “unicorn” was first applied to technology companies exceeding $1 billion valuations in 2013, a cottage industry has emerged tracking the rise of these new creatures. In her book Billion Dollar UnicornsSramana Mitra claims, “These days, a vast majority of entrepreneurs are looking … to build billion dollar unicorn companies. Venture capitalists have always looked for unicorns to fund.”

Even the Wall Street Journal has a “Billion Dollar Startup Club” tracking unicorns.

Once an endangered species relegated to myths and fairy tales, unicorns now roam the earth in increasing numbers. Investors have crowned 175 new unicorns since 2015, ascribing a combined valuation of over $650 billion. New unicorns are now crowned weekly, over 100 since 2017, with much corny fanfare.

As companies stay private longer, unicorns have replaced initial public offerings as a media destination of choice. But for investors, unicorn status is a funding event, not a destination. Less than 30 percent of venture-backed technology companies that achieved unicorn status from 2012 to 2015 have realized exits for investors to date.

Just a decade ago, the average time from inception to IPO for successful tech startups was about nine years. Now it takes startups six years on average to become a unicorn and often longer for investors to realize their investments, once unicorn status is achieved. Unicorn status recognizes high potential but many of these companies are still toddlers trespassing in a world inhabited by giants, where the risk of entering a tech major “kill zone” is ever present.

Source: NGP Capital research.

So why the fuss over unicorns?  First, unicorn exits are rare.  As the chart below shows, just 96, or 1.1 percent, of 8,600 venture-backed exits since 2013 have sold or went public for $1 billion or more. And yet unicorn exits account for 40 percent of total exit value, so the vast majority of venture gains are realized in these deals.

Analysis of 8,600 venture-backed exits since 2013. Source: NGP Capital, PitchBook, Crunchbase.

A second reason that unicorns attract attention is that the next generation of iconic technology companies are likely to emerge from this group. While valuations of unicorns are generally forward priced, they have performed well as an asset class. Nearly 80 percent of unicorns that have exited since 2013 have done so at a valuation above their initial unicorn valuation.

What accounts for the rise of unicorns? The higher operating costs of running a public company are a deterrent for some entrepreneurs taking their companies public. But at least two other more important motives are driving the emergence of unicorns.

First, as venture and private-equity firms raise larger funds, capital-intensive companies can now raise larger rounds from private investment sources. Entrepreneurs and investors may prefer to keep companies private, as they have more degrees of strategic freedom than at public companies that must answer to investors each quarter, especially as active secondary markets provide liquidity for early-stage investors seeking exits.

Alibaba offers a good example of the relative advantages of private companies. In 2012, Jack Ma took Alibaba private to alleviate “the pressures” of having a listed company. As a private company, Alibaba quietly made numerous acquisitions and launched new services.

When it relisted as a public company on Sept. 19, 2014, Alibaba had a $231 billion valuation, or 25x the value at which Ma took Alibaba private just two years earlier.

Remaining private also allows private-equity investors to capture more value from their best performing portfolio companies.  Consider the valuations of such companies as Microsoft, Apple, Amazon and Google at their IPO relative to today. Google is worth 26x more now than at its IPO in 2004. Apple is now worth 562x more, Amazon, 1,161x, and Microsoft 1,500x.

Uber, Ant Financial and Airbnb might have gone public years ago, but their investors surely will have done better by waiting.

We have been in a prolonged bull market so the buy-and-hold strategies that have performed well over the past nine years may not be an optimal strategy for all seasons. Yet as long as ample capital is available, companies will stay private longer and more unicorns be crowned with much fanfare.

But do not be fooled. Investors may enjoy the journey but the destination is the ultimate reward.

Paul Asel is managing partner of NGP Capital and a global technology investor across the U.S., Europe and Asia for over 25 years. Follow him on Twitter at @PaulAsel. You can reach him on LinkedIn at www.linkedin.com/in/paulasel.