It's much much easier to hire good engineers at a lower payrate when the signaling is good because they actual believe the paper equity they get is actually worth something down the road.
In the same vein, positive signals and the good press that comes with it helps you win business. In our case (no where near a unicorn), but we were featured in a local paper. That paper was seen by the CEO of a company we were in negotiations with and were stuck down on a lot of DD work. They wanted all these assurances we would still provide services and won't just take the money and go bankrupt a year later etc etc.
CEO saw us described as the "next big thing in X" and intervened. He told us later he "knew" we were going to be huge and wanted to lock us in early as a partner. Contract was signed less than a week later.
Unicorn status is largely a vanity metric, but it's also a power signal that if used correctly, gives a lot of benefits to the startup.
ps -- you can't blame founders for responding to the market. If potential employees overvalue unicorn valuations and undervalue 83b or long term options, well, I'm not capable of changing their minds. I sell to the market I have, not the market I wish I had.
While I would say that it seems probable that many startup employees are young and inexperienced enough that it services the founder to play these games, I'd definitely say that the incentives are definitely in favor of this dynamic. It's unfortunate. I'd prefer solid financials and growth, just like you. The only real way to avoid this kind of game is not to play -- have an independently wealthy founder/stakeholder, or a very close relationship with an angel investment firm that can afford to be long term. It's challenging to find that from people managing Other People's Money.
In my first startup we were so happy anyone would be interested in funding us we took on, in hindsight, some pretty bad terms. But having said that, our first raise got us onto a tech blog where a person reached out intrigued by what we did and turned out to be our best engineer.
It's really a calculated risk. Despite all that, since we got acquired reasonably early on, our engineers made a pretty solid return.
banks found that out the hard way at the end of 2008, when companies wouldn't do business with banks with falling stock prices. even facebook found out the hard way after IPO when its stock was tanking and many tenured employees where questioning whether to stay. stock / valuation performance matters a lot.
In the self-driving car area alone, we have:
- Cruise Automation. Showed a video of simple lane following and hyped it as self driving. Got acquired by GM for 1 billion. Claimed to have a production-ready car in 2017. GM now trying to dump them. Being propped up by funding from Softbank.
- Otto. Showed a video of a self-driving truck. Turned out this was on an isolated road with lead and trail vehicles preventing any interference. Acquired by Uber. Valuation only 680 million, though. Used to hype Uber valuation. Self-driving technology so fake it killed a pedestrian. Being propped up by funding from Softbank.
- Tesla. Showed a video of a self-driving car in 2016. Turned out this was the one successful run from many tries. Full self-driving never seen again from Tesla. Softbank and Tesla discussed funding but Softbank declined.
Are those companies unicorns. No. They seem to be valued for what they actually do. Which is replace a small number of low-wage employees with expensive hardware that requires extensive support infrastructure.
Think of what it looks like if this really works. They get a few major airports signed up for "transportation as a service". Their mini-buses go between terminals, out to long-term parking, and out to rental car lots. Fine. So now, at each airport, you have to have a garage, maintenance staff, a control center, and some arrangement for dealing with problems. All the same plant as a regular bus operator, plus the high-tech part, plus it has to be close because these things can't drive some distance on regular roads to a garage or parking lot.
It's "transportation as a service", which means you have to pay for all problems. Which will happen. You'll have people cleaning off graffiti, fixing corroded sensors in winter, towing in failed vehicles, and dealing with angry riders who missed their plane. All you've saved is the cost of the drivers. So you're probably not making big money off this.
It's so much easier at the hype stage. You don't even have to perform, let alone survive on your own cash flow.
Oh wait...that didn't work out so well for Blackberry (or Palm or Microsoft). Does anyone remember when Creative dominated the media player market? Or when everyone thought Sony would take over the electronics world? When everyone thought Yahoo needed to be broken up before it threatened the internet?
if I were investing in that sector I wouldn't discount them as a meaningful contestant, remembering they can always buy their way in to third party tech.
One thing most of Tesla's competitors all have in common is that their business interests are opposed to Tesla's business interests. This means that a licensing of self-driving tech is extremely unlikely.
Remember: having tech is one thing, getting it to market at scale and sorting out legal and regulatory issues, cross-border issues, distribution agreements, etc. is quite another. Tesla has done this before and thus presents a nontrivial value-add for tech holders, quite aside from "money on table now".
However, in the public cash equity markets there is an actual benefit to having a "large" market cap.
note: Here I'll use market cap for public companies and valuation for private companies as measuring roughly the same thing even though they have some differences.
One of the greatest tail winds a stock can have is to be in a popular index, this means that ETF's will be a forced buyer of their stock.
Most indexes have a market cap component and the amount of money tracking large cap indexs dwarfs the amount in small cap indexs so a larger valuation is obviously useful.
It can also help public companies borrow as debt to equity is a ratio that most people consider when choosing to loan( buy bonds) from a company so again market cap matters.
It also helps a public company pay its employee's in restricted shares as these can be cashed out immediately by employees for actual money as the shares come off restriction so again a growing market cap has the benefit of giving employee's raises without any money leaving the company.
Microsoft used this better than anyone during the 80's and 90's.
It's less clear to me why a valuation of over $1B matters to a private company though.
Even stock options don't really seem to matter as a reason for wanting a larger valuation as typically employee's can't immediately convert options to cash. In that case only the IPO price(hence public valuation would matter).
Is there any reason other than signalling that this company belongs with the likes of Uber and Airbnb?
EDIT agree with the child posters but they don't really answer the question of why $1B is important for the valuation in a way that, say, $990M would not be.
* A supplier to the unicorn may perceive the company as a future star, which makes them decide to provide goods & services at a discounted price with the intention of having their business for multiple years with potential for new business areas
* A future employee can perceive the company as "the next big thing" and decide to work there in part, because of their status symbol
* The medium-large investors may mentally perceive the company as a 'sure bet'.
* Small investors may perceive the company as "one of the ones that the big investment guns have approved off"
* Future & current customers may perceive them as a successful company
* The 'unicorn' name is catchy, increasing the brand value
All in all, 'unicorns' is just a measurement stick. In theory a $990M can be just as successful as the $1B in the medium-long run, however, the perceived view from humans (yes, all of us), can have a material impact on the business
I'm willing to bet there are gaps in valuation distributions such that a $1B valuation is statistically more likely than a $900M valuation. I think by the time the valuation is that high you might as well throw in an extra ~10% valuation to get yourself the extra marketing of investing in a unicorn.
Is that a thing people actually say and not just from the TV show? Not being facetious to you, it just makes me laugh to hear/read this term :)
> hence public valuation would matter
There is your answer. IPO valuations have to come from somewhere, and the most recent private valuation is usually a good starting point for what investors will pay.
If you sell a car, you set the price by considering how much you paid for it and how much people are paying for similar cars. End of bad analogy.
Brand value / free marketing. Hitting the 1B threshold unlocks a lot of publicity that 990 million doesn’t. The buzz that it generates aids both sales and recruiting efforts.
Anything that helps anchor the price for a bid is helpful, so you'll always want to point to a number that's as high as possible. You will also want to call out which series of funding that number comes from, and hopefully those two things go hand in hand.
Here's a scenario that happened recently. Investors X and Y invested a $30 million Series A in UnicornCompany. Lets just say its a $200m valuation.
Those same exact investors invested a $50m Series C at a $2 billion unicorn valuation (no new investors).
Doesn't that mean their initial investment is now worth 10x in the open market? Thus making their return at least $300m on $80m invested?
Mark-ups serve as marketing for the next fund which they get a % of an annual basis. The time horizon to see any company turn to cash is so long that their major day-to-day level is to market a strong rising portfolio to new LPs for more money to manage.
VCs generally don't get any meaningful impact from intermediate numbers, they get their numbers - both regarding investor returns and their carry fees - only on exits. So the share they get for that money has a direct impact on how much money the VC personally takes home after the exit. Any before-exit valuations have only a PR effect for them (which may be a factor if they want to raise a new round anyway right now, and are failing at that - but if they can raise a new round, then this PR won't bring them any extra profit), and any useful effect on the secondary market is too far in future; if there's an investment round happening now, then any potential buyers would be in that investment now; at this point the participating VCs are participating because they want to increase (or at least maintain) their share, not divest it - and if they want to divest after a year or so, the valuation PR effect will have faded.
The benefits of such a valuation to the startup, on the other hand, are much more clear.
The incentives can change if you look one level deeper. VCs often need to start raising a new fund before all the positions in their existing fund are fully liquid. By artificially inflating the valuations of their old fund, they can demonstrate high performance to LPs, which may help them raise more capital for the new fund.
In normal circumstances, where they can raise the amount the next round should have (i.e. one that they can invest with a good return) this isn't helpful. More capital for the fund doesn't necessarily benefit them - they need enough pledged money for the fund, but if they get the ability to pay twice as much for the same startups, that only decreases their take-home carry after the fact; if they have so much capital that they have to invest it in worse startups just to invest it in the expected timeline - that means worse results and less profit for them; if they raise extra capital for the fund that's sitting unused, then it decreases their overall profitability ratios and again means less profit for the VCs personally.
However, if it's difficult for them to get enough investors for the next round (e.g. during an economic downturn) then yes, in such particular cases the PR advantage might be useful. But it's not in most cases, and not now, and the impact isn't that much - the organizations who invest in VC funds (i.e. the limited partners) aren't stupid as well, they can afford to do a lot of due diligence and all the data for the valuations and discussions and doubts about the valuations is available for them. You could just as well argue that if they inflate valuations, then the community of limited partners might think that they're not prudent with their money and avoid investing in their next fund. PR smoke and mirrors works well on the general public, but less well (though not at zero effect) on the large investing institutions.
Where is the line between that and a ponzi scheme? How legal the artificial inflation is? Or is it that the valuation that's being artificially inflated isn't a return per se, but rather highly correlated with returns?
However after the C the VCs may be able to report a 10x return to their investors.
My company has 10 shares total and I manage to get you to buy one of them for $100. The logical conclusion is that the shares are worth $100 each and the company is worth $1000. You hold 1 share, and I hold 9 shares. I also have the $100 you gave me. So one can say that you bought 10% of the company at a $1000 valuation.
But let's say I don't do anything at all with the money you gave me and I had no other money to begin with. What that means is that you have 1 share and I have 9 shares and $100. If we liquidated the company now, you would get $10 back and I would keep $90. The company has a value of $100.
Now let's say that somebody is really interested in buying shares. I give you the OK to sell your share and somebody offers to buy it for $10,000. You sell your share for $10,000 (10% of the company). The logical conclusion is that the other 9 shares are worth $90,000 and the whole company has a valuation of $100,000. But I still only have $100 in the bank :-)
Now, let's say that encouraged by the huge profit you made, you buy 4 shares at $20,000 each from me. The valuation of the company is logically $200K because there are 10 shares and the last time someone bought some it was for $20K each. You own 40% of the company. I own %50 of the company and they person who bought the original share from you owns %10 of the company. The company has $80,100 in the bank. You try to sell your 4 shares now, but nobody wants to buy. The shares have a nominal value of $8,010 each ($80,100 / 10 shares), but nobody feels like buying. Your shares are worth 0 because I control the company and don't want to liquidate. Basically, I conned you into giving me $80,100 :-)
Shares are worth what other people are willing to pay for them. Whether or not someone will be willing to buy your shares back for the current "valuation" of the company depends a lot on the circumstances. Whether you are even able to sell your shares depends on agreements you made, etc, etc. You can easily have a company with a $1 billion valuation whose stock is worth less than toilet paper in reality.
Companies that are pre-IPO are really ripe for the hype machine. You generally can't trade their stock except at a "liquidation event". You can invest in them, and their valuation might climb, but you can actually realise any of that profit. If they pull a Theranos on you, then you lose all of that money. Once a company has IPOed, the stock is traded freely on the stock market. Since it is liquid, you are more likely to be able to sell your stock close to its current valuation. Keep in mind that this is still not the same as value -- stocks usually trade a prices of multiples of the current value (because people believe the companies will increase in value over time).
Edit: I have trouble multiplying by 4... :-P
On the positive, it's generally good to raise money when you don't need it. You're more likely to get the most favorable terms. (Or, stated diffrently, it's hardest to raise money when you need it most, with a zero cash date looming).
On the negative, it creates a high bar to clear for the next round of funding. If you don't raise enough, and need more funding later, doing a down round is extremely painful. Worse, if you have anti-dilution and other provisions, the cap table gets blown up. Lots of agita.
Public companies: different circumstances (market cap is a currency for acquisitions).
Finally, I'm respectful of audacious and aggressive entrepreneurs, but I've got a very sensitive hubris detector. A billion is an arbitrary ego number, and "We don’t entertain offers.... . . and it’s literally not worth the time of day, talking" is crazy. Tell that to Groupon shareholders that held stock during Google's (reported) ~$6b offer in 2010. Ouch. Pride goeth before the fall.
I hear this a lot, but I don't quite understand the sentiment. It's painful for whom? The earlier investor, sure, but not the founders.
Scenario 1: I have a round of funding at $1MM valuation then later a round of funding at a $10MM valuation.
Scenario 2: I have a round of funding at $100MM valuation then later a round of funding at a $10MM valuation.
Scenario 2 has a down round, but it's unclear to me how anyone in this scenario is worse off besides the suckers who bought in at a too high valuation. They just overpaid; that's all. The business and the other shareholders are strictly better off because they were able to get more cash for the shares sold.
If A16Z gives a company 100M at a 1B valuation, it becomes a unicorn. Does the same apply if my neighbor gives me 400M for 40% (1B valuation) of my company? Does that make my company a unicorn?
If it does, what about if he gives me $1000 for 1 millionth of my company? Or maybe with 5 or 6 other investors bringing on their $1000 as well at the same valuation and adding validation?
Whose valuation counts and why?
That is to say, if your neighbor has 40 million dollars in the first place, he almost certainly counts as "accredited", unless he's also got 50 million sitting around in liabilities.
Slack Technologies Inc. is planning to go public through a direct listing, "
example: as an employee you own 10% of the company. The 10% is worth $10. After company raises a 100M round and dilution has occurred, you own 1% of the company, but that 1% is now worth $50
who is being treated unfairly? I don't quite understand
Investors in the unicorn know it's a ridiculous market cap, but will lock in preferential payout on the exit. This means that while the employee private equity may increase in value, the employees get pennies on the dollar during the exit because the majority of the payout goes to the investors who inflated the price to begin with.
It gets worse when employees pay taxes on the equity at the inflated valuation, but there are ways claw that back later.
But you don't have the counterfactual to know what the company would have exited for without the ridiculous valuation. Probably a lower number.
The difference is the expected value of income that the employees are given in equity, which is especially nefarious.
This is not a thing that happens in the vast majority of circumstances. Preferences are for downside protection not a way for investors to actually make money. No one invests with the goal of making use of them.
Investors who play in this arena are not stupid: https://angel.co/blog/liquidation-preference-your-equity-cou...
Per your link, they sold for $425 million.
The investors lost money.
That is not the outcome they were hoping for. However, their preferences did provide them downside protection which was, as I noted, their purpose.
1) Good Technology was valued at $1.1 Billion.
2) The investors lost money, but the employees lost much more.
-> This is the problem with unicorns.
You've completely missed the point.
Numeric value is determined at time of sale. Without a sale, the object has no "value". It might be useful to you in some way, but it's value is 0 unless you can sell it. There is no such thing as "underlying value"
example: I have a normal orange that I bought for $5 at the supermarket. The orange's underlying value is $5. If I sell it to my friend for $10, the value of the orange is now $10. If no one is willing to buy it, its value is $0.
The same thing happens when you raise a new round. When you raise a new round, you've made a "sale": someone paid money for it. That exchange of money/shares is what determines value.
To use your orange metaphor, while it is true that if no one else wants the orange the value of the orange is $0, I don't have to sell it to have a good idea of what the price of an orange is. For example, if there are people offering to buy my orange for $8 and I know that a typical bid-ask spread for fruits is %50 of the bid and most transactions occur at midpoint I can be relatively certain that the orange is worth $10 despite no transaction occurring and there being no market for oranges (if there is a generic orange market you have access to then the entire point becomes moot since you can just take the market price).
"People offering to buy" is key.
It's very easy for a founder to tell employees "hey I met with a VC yesterday, and they were interested in investing at $x a share!". It's easy to say that, but making it actually happen is the real deal. When someone sign on the dotted line and hand over real $. It's a much more accurate test of value.
That's not how the math works. In the prior round people didn't know the value of the company. Maybe it was worth $100M, maybe it was worth zero. The expected value (weighted average probability of all scenarios) of your stake in the company was worth $10 per the parent
Money is cheap right now, so it makes sense to get a lot of it while you can so you can ride out the next downturn when money will be expensive.
When I say that "money is cheap" I mean in dilution cost, not interest. Although to be fair a lot of corporate debt can be written off without destroying to company so it's not a bad option for bigger companies to issue debt either.
It might not make an individual share worth more (because of dilution), but it 100% absolutely makes the total value of the company go up.
Translating this bafflegab into english is educational:
> We used to be profitable because people liked our product enough to pay more for it than it cost us to produce. Now we're not, so... unicorn?