The risk of collapsing the neck in pursuit of unicorns

In the world of Wall Street, where numbers decide everything, one number is especially desirable: one billion. Startups, whose price reaches $ 1 billion before entering the stock market - the so-called unicorns - can attract the attention of prominent venture capital firms and the best professionals from across the country.



This figure is so important that currently 41 companies are valued at exactly $ 1 billion, according to a report by a venture capital research firm CB Insights. And this statistics shows that 103 startups have already exceeded the cost of a billion dollars, even though the valuation of companies may be more art than science, and is based on a wide range of criteria that do not always put financial data above all.

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But in the race for the title of unicorn - this name was chosen mainly because these creatures were very rare in the myths - start-ups take on some non-standard risks that could harm them.



In order to attract the attention of investors who will help start-ups to advance to the cherished goal of $ 1 billion, some of the young companies make deals with those who have just recently joined the world of venture capital. Such agreements can harm both company employees and novice investors.

Big and small unicorns

Of the 142 international unicorns - private companies, valued at $ 1 billion and above - more than half have a value in the range from 1 billion to 2 billion dollars.



The idea of ​​economic speculation with bloating value estimates is not new. What is new is the psychological pressure faced by the founders and managers of private companies in order to achieve the cherished figure of $ 1 billion, and the speed with which the decline in open markets affects closed sites. All this in the long run increases the aspirations of startup managers, designed for short periods of time.



For professional investors, these agreements can guarantee the expected return on investment, if the next transaction — it could be another round of financing, an initial public offering on a stock exchange or a sale — would be valued lower than expected. This sometimes occurs at the expense of employees, whose shares are eroding, unlike those belonging to investors. It is normal when the market goes up. But the market has been and remains turbulent.



Approximately 30% of unicorns' investors agreed on measures to protect against the so-called downward initial public offering of shares - a situation in which the results of the proposal showed a lower score than in the last round of private financing (according to a study by the law firm Fenwick & West, conducted in May). In the case of acquiring startups, the cost of all the unicorns studied by Fenwick & West will be cut by an average of 90% before investors incur losses.



Long-term results can be disastrous for some of these startups. Engineers and sales representatives who have spent years working in the hope of earning big money can desert the crowds, see how their wealth on paper loses value, or wait for an initial public offering of shares that was delayed while the company tried to grow to the amount in which it was estimated.



“There is a great deal of disagreement between employees and founders on the one hand and investors at a late stage on the other,” says Shriram Bhashyam, co-founder of EquityZen. “There are far fewer shortcomings in being an investor in one of these transactions than the owner of ordinary shares.”



To protect employees from the risk of a downward round, some companies have decided to stay private longer. Startups of this year waited 7.7 years before entering the stock market for their first round of financing. For comparison, in 2011, this figure was less - 5.8 years according to PitchBook data.



Rounds of funding unicorns surpassed IPO and June sales by four times, according to various PitchBook analyzes.



From Wall Street to Washington and the academy’s towers, people are buzzing about what some have called a disastrous concentration on short-term profits in corporate America.



However, a handful of companies, including Apigee, Box and Hortonworks, entered the stock market at a lower valuation than their private rounds showed last year. The company Good Technology did it more than a year before it was acquired by BlackBerry in September of this year for $ 425 million, which was less than half of the $ 1 billion private valuation of a startup.



After the stock market fluctuations this summer, it has become even more difficult for private companies to enter it or get the highest rating when selling, as investors, who usually focus on joint-stock companies, have now turned their attention to private firms.



The largest joint investment funds, including T. Rowe Price, BlackRock, Fidelity Investments, Janus Capital Group and Wellington Management Company, have invested $ 16 billion in private companies over the past three years to help them increase their value (according to with CB Insights data). In 2015, these investors invested eight times more funds in private companies than in 2011. And all this in addition to funds from hedge funds, venture capital and private equity firms, as well as corporate investors.



Decreases in the stock market have forced mutual fund managers to rethink and restrict their private investment strategy, say people dedicated to these strategies. Also, in their opinion, without all the investment capital that has been spinning in Silicon Valley for the past few years, some unicorns would have had much more difficulty in attracting the next rounds of funding with a growing appraisal.



"The 5-10% discrepancy usually does not cause any unrest in the market," says Ian D'Souza, behavioral finance lecturer at the New York School of Business, Leonard N. Stern. “It's just some kind of infection brought by new investors in a growth space that was not five years ago.”



Adley Bowden, an analyst with PitchBook, claims that for the same reason, investors in public markets have also become more demanding in relation to initial public offerings. Instead of taking metrics such as profit growth and user experiences, stock buyers have become more focused on revenue.



The threat of a lower score leaves some unicorns in limbo. At the moment, they can’t do anything about it, since many have already planned a budget. But money is not enough forever - especially for those companies that tend to spend it quickly. Some of these startups will not achieve the assessment they were eager for and will be forced to tighten their belts in the next round of funding. Others may go bankrupt if their founders cannot find even more money or a way to sell their unicorns.



“As an entrepreneur, you need to make sure that the post-investment valuation of a company is exactly the amount you get,” says J.B. Pritzker, co-founder and managing partner of the Pritzker Group, which has a venture business unit. - You do not need too high a rating.