The risk of turning your neck in pursuit of unicorns

In the Wall Street world where numbers are everything, one number is especially welcome: one billion. Startups, the price of which reaches $ 1 billion before entering the stock market, the so-called unicorns, can attract the attention of prominent venture capital firms and the best specialists from all over the country.

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

But in the race for the title of a unicorn - this name was chosen mainly on the basis that these creatures were a very rare occurrence in myths - startups take on some non-standard risks, which can harm them.

To attract the attention of investors who will help start-ups move towards the cherished goal of $ 1 billion, some of the young companies are entering into deals with those who have only 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 or more — more than half have value ranging from $ 1 billion to $ 2 billion.

The idea of ​​economic speculation with inflating cost estimates is not new. What's new is the psychological pressure faced by the founders and heads 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 areas. All this in the long run increases the aspirations of startup managers, designed for short time periods.

For professional investors, these agreements can guarantee the expected return on investment if the next transaction - this may be another round of financing, an initial public offering on the stock exchange or a sale - will be priced lower than expected. This sometimes happens at the expense of employees whose shares are eroded, unlike those owned by investors. This is normal when the market goes up. But the market has been and remains turbulent.

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

Long-term results can be detrimental to some of these startups. Engineers and sales representatives who have spent years working in the hope of making big money can desert in droves, seeing how their wealth on paper is losing value, or waiting for the initial public offering, which was delayed, while the company tried to grow to that the amount in which it was estimated.

“There is a lot of disagreement between workers and founders on the one hand and late stage investors 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 lowering round, some companies have decided to stay private longer. This year’s startups 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.

Unicorn funding rounds surpassed June IPOs and June sales four times, according to various PitchBook analyzes.

From Wall Street to Washington and the academy towers, people are buzzing about what some call the disastrous concentration on short-term gains in corporate America.

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

After stock market fluctuations this summer, it became 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 eyes to private firms.

The largest co-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 (in line with with CB Insights data). In 2015, these investors invested eight times more in private companies than in 2011. And all this, apart from funds from hedge funds, venture capital and private equity firms, as well as corporate investors.

Declines in the stock market forced mutual fund managers to rethink and limit their private investment strategies, say people who are dedicated to these strategies. Also, in their opinion, without all the investment capital that has been spinning in Silicon Valley over the past few years, some unicorns would have had much greater difficulty attracting the next rounds of funding with a growing valuation.

“A 5-10% gap usually does not cause any market unrest,” said Ian D'Souza, a professor of behavioral finance at New York Business School Leonard N. Stern. “It's just some kind of infection brought by new investors into a growth space that was not there five years ago.”

Adley Bowden, an analyst at PitchBook, argues that, for the same reason, investors in public markets have also become more demanding on their initial public offering. Instead of taking metrics such as profit growth and user experience, stock buyers have become more focused on revenue.

The threat of a lower score leaves some unicorns in limbo. At the moment, they can not do anything about it, since many have already planned a budget. But money is never enough forever - especially for those companies that tend to spend it quickly. Some of these start-ups will not reach the mark they craved, 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 the company is exactly the amount you will receive,” says J. B. Pritzker, co-founder and managing partner of Pritzker Group, which has a venture division. “You don’t need too high a mark.”