Private Equity Aspirations: Investing in Unicorns

Over the past decade, unicorns have stepped off the pages of fairy tales and taken over the imagination of investors. It has been 11 years since Aileen Lee coined the term for startups that reached $1 billion in their valuation, and since included companies like SpaceX, Stripe, Databricks and the recent darling, OpenAI. In an age of diminishing public offering returns and growing interest in private equity, finding the next one became something of a Holy Grail. While few companies reach unicorn status, the potential benefits of investing in one can be extraordinary. However, there are also significant risks involved, and differentiating a good investment from a bad one requires extensive analysis, access to quality data and perhaps a bit of fairy dust.

Our series on Unicorn Investing is here to support with the first two: in the course of 3 special blog posts, we are going to explore the definition and statistics of investing in these rare companies, followed by an exploration of the risks and rewards associated with it. Finally, we will outline strategies and approaches currently prevalent in the investor community. Let’s get hunting. 

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What is a unicorn company?

A unicorn is a privately owned start-up that has been valued at over $1 billion. A percentage of unicorns choose to go public following an initial public offering (IPO); some, increasingly so in the last few years, including Revolut, Vinted, WebFlow or SpaceX, opt to remain private. Still others opt for getting acquired by larger companies. When Alphabet acquired YouTube or Meta Platforms’ purchased WhatsApp; both companies were valued in the billions.

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Top 10 unicorns in the world

The 10 biggest unicorns by post money valuation are 4 from USA, 3 from China, 2 from India and 1 from the UK (Crunchbase: Unicorn company list).

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Top 5 industries with number of unicorns

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The graph below illustrates ten of the most valuable unicorn companies that have their primary base of operations in the United States and have filed the necessary documentation publicly around their recent raises. These valuations are based on the last reported official round, not including secondary tender sales or trading; this picture starts to look abstractly different when updated to today’s market matrics. In our upcoming series, "The Allure and Pitfalls of Unicorn Investing," we will delve into the current implied valuations of unicorn companies, taking into consideration the impact of secondary tender sales on their overall market value.

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The chart presents the six leading industry verticals, ranked by the quantity of unicorn firms that meet the criteria outlined in the previous section.

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Private equity is notoriously opaque (which is what we battle here at ApeVue with transparent data), but a unicorn can be as risky to invest in as it is alluring. Primary round valuations are determined by venture capitalists and private investors during its funding rounds, based on factors including market potential, growth rate, capacity for innovation, and company leadership, in addition to other KPIs. However, some of these early-stage companies haven’t been market-tested as their liquidity is held close to the vest, at least not on the scale required for true success in ROI. As such, the valuation represents a bet on future growth and overall potential.

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How is potential assessed?

‍Innovation, disruption, technology. In most cases, the product or service of unicorns aims to completely change how a market operates, shift paradigms or simply offer a magnitude better solution to an existing problem.

First mover advantage. Being the first to introduce a product or service to market is a great way to become a unicorn - however, only innovation that is not easy to copy can reliably maintain the gains of first-mover opportunity.

Growth focused.  Ambitious and often aggressive growth strategies and good traction are needed as proof to achieve a funding level that brings valuations over $1 billion.

Likely B2C. About 60% of unicorn start-ups are DTC, selling directly to consumers, allowing for more competitive prices, direct access to their customer base and great opportunities to build CX and relationships for driving growth.

Technology is still king. Most unicorns emerge from a tech-related field. Completely new or a tech-driven approach to stale markets as well as fast reaction times allow for strong singular value propositions and an agile, test-and-learn approach to marketing, fuelling growth.

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Rare as unicorns, might fail faster

But how rare are these outliers? Aileen Lee chose the term unicorn after discovering that between 2003 and 2013, out of over 60,000 startups, only 39 of them were valued at over $1 billion. The landscape is dramatically different today and unicorns now number in the thousands. Bain research shows that nearly 2,500 of the companies founded in the past 20 years have achieved valuations over $1 billion, although they include publicly traded companies too.

Dealroom’s data follows 2,800+ startups that have achieved a $1B+ valuation or exit since the year 2000, across more than 420 cities worldwide. Over 1,400 of these are still private and venture-backed. This is thanks to the large amount of capital that surged into the markets, as well as a mounting enthusiasm for tech start-ups and scale-ups.

A peculiar detail about them is however, that less than 1% are generating $1 billion in revenue. This is of course not an automatic red flag: many ambitious founders focus on the long term, building market-changing products and investing in talent as well as innovation. However, this is a trend that marks Unicorn Investment as potentially riskier and it’s worth remembering that one glowing valuation is no guarantee of return on investment. It is enough to remember the 6 weeks in 2023 that saw WeWork, ($11 billion in funding as a private company), Olive AI, (healthcare, $852 million in funding). Convoy, (freighting, $900 million funding) and Veev (home construction, $647 million funding) all file for bankruptcy or shut down.

There were many other unicorn casualties last year and Carta’s Head of Insights called 2023 the hardest year for start-ups so far. Why might companies that are so promising, fail? What to look out for, if you are considering investing in one? (And ideally, getting in at an early stage.

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Overvaluation

Running out of cash and failing to raise more capital is the number one reason (38% of all respondents) why startups fail, according to CB Insights. The hype/enthusiasm/excitement around a startup at the early stages unfortunately can contribute to this. The high valuation before any real KPIs are shown is followed by aggressive growth plans, teams might grow too fast for good cohesion and healthy management practices and unicorns might collapse under their own weight. If that doesn’t happen, raising the next round is still tricky. Are they able to show enough traction since the previous one? Have they delivered on the hype of the early days? Are there any competitors nipping at their heels? All these factors can lead to investors being wary of throwing bad money after good, and subsequent rounds will either fall short or fail to materialise.

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Failure to go public - or what happens after IPO

While there is an increasing trend to stay private, IPOs are still the main event materialising substantial return on investment for a large share of growth stage asset managers and venture capitalists. Tesla, AirBnB and 23andMe took between seven to 13 years before going public; many more recent unicorn IPOs took prolonged market-driven hits to their valuations, including Uber following its 2019 debut. We will present more on this topic in our next series “The Allure and Pitfalls of Unicorn Investing”.

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Opacity of the private markets

A problem extremely familiar to PE firms, auditors and asset managers: valuations can be hard to gauge, plus easy to foil and transparent and timely information hard to come by. While this is not a direct cause of failure for startups, the environment can certainly curb investor enthusiasm, leading to decreased trust and smaller funding rounds.

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Increased cost of acquisition

With many startups and unicorns operating at razor-thin margins, the increasing cost of paid media can deal deathly blows. Ambitious growth plans usually depend on highly efficient marketing plans and optimal cost per acquisition. If market trends, competition or customer behaviour raises these costs, entire business models might go bust. Unicorns really are mythical beasts, overcoming lofty odds, and keeping up the good fight even after they achieve this status.

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9 out of 10

startups fail

Source: startup Genome

7.5 out of 10

venture-backed startups fail

Source: Shikhar Ghosh

2 out of 10

new businesses fail in the first year of operations

Source: Bureau of Labor

2/3 of IPOs

underperform the market, after 3 years od their IPO

Source: Nasdaq

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Why are unicorn companies so fascinating?

Given the emotional rollercoaster and high-stakes risks described above, it is no wonder that the thrill-seekers amongst us are keen to follow, spot and invest in the next unicorn.

The allure of unicorn investing lies in the promise of astronomical returns. These companies often disrupt industries, offering innovative solutions to longstanding problems. Their ability to quickly capture market share and generate substantial revenues fuels excitement among investors.

For venture funds, family offices, and asset managers like our clients, portfolio diversity is of course key. While risk is an inherent part of investing, a single multi-billion dollar exit from a unicorn can substantially boost the overall portfolio's performance.

Besides, we shouldn’t discard the emotional motivations: spotting unicorns early represents opportunities for early-stage seed investors to support potentially transformative businesses. Even at later stages, the excitement of true disruption, innovation happening right before our eyes and charismatic people building game-changing products can drive decisions. In essence, unicorn companies represent purposeful entrepreneurial success, embodying innovation, growth potential, and the promise of substantial returns for investors.

How do you prepare for an opportunity that’s right for you? We will continue to explore in further blog posts.

In the meantime, check out some of our own Unicorn analyses, on Chime, Hugging Face or Kraken.