There used to be a time when entrepreneurs would dream of building million-dollar businesses. They’d wire together some gear that they picked up in Radio Shack and hope that one day it would all work well enough to give them seven figures and a large house. For techpreneurs today, that amount is barely worth getting out of bed for, and in Silicon Valley a million bucks won’t even pay for a parking space. As Justin Timberlake playing Sean Parker in The Social Network put it, “a million dollars isn’t cool. You know what’s cool? A billion dollars.”
By that reckoning, Facebook is now very cool indeed. The company has a market capitalization of nearly $430 billion, and while it’s miles ahead of the pack, it’s not alone in what HBO show Silicon Valley has called the Three Comma Club. CB Insights, a tech market intelligence company, has identified no fewer than 194 billion-dollar tech companies worldwide, including Uber ($68 billion), Xiaomi ($46 billion), AirBnB ($29.3 billion) and WeWork ($16.9 billion).
In a 2013 Techcrunch article, Aileen Lee, founder of Cowboy Ventures, described these companies as “unicorns,” creatures that are “extremely rare and pretty awesome.” Looking only at US-based software companies started since 2003 and valued at over $1 billion by public or private market investors, she found only 39 companies that fitted the bill. They made up just 0.07 percent of all venture-backed consumer and enterprise software startups over the period. Each year during that decade four unicorns were born, and in total, only between one and three “super-unicorns,” companies worth more than $100 billion.
Two years later, Aileen Lee looked again, focusing on the period from 2005-2015. This time she found 84 unicorns, a rise of 115 percent. The period had not produced a super-unicorn but it had created three new “decacorns,” companies worth more than $10 billion, bringing the total to nine, including Uber, Twitter, WhatsApp and Snapchat.
Lee suggested a number of reasons for that sudden growth in ten-figure companies. Large, growing, global markets linked through smartphones and social networks have made good products easier to adopt everywhere. Get the product right, and a company can now conquer a global market faster than ever before.
Those markets are also now winner-takes-all. Branding, scale, network effects and giant amounts of cash mean that once a product moves into a niche, it owns it all. For search advertising, there is only Google. For social media advertising, which is also mobile advertising, Facebook leaves only crumbs for competitors. Uber has no rivals other than the taxi firms with which it is in open conflict rather than direct competition. Companies that try to penetrate the market are either bought out, like Instagram, or if they refuse the cash, risk seeing their features copied before being crowded out, like Snapchat.
There are also more sources than ever for later stage private capital, often with lower return demands, while the rising NASDAQ has been pushing up prices across the sector. The 2012 Jobs Act allowed more shareholders to invest in a company before it goes public, enabling companies to soak up more private capital before testing that valuation in public. According to Fortune magazine, investors who might once have balked at putting money into a company that promised massive returns in the distant future have been burned by missing out on the rise of Facebook and are more likely to give a fairy-tale valuation. Those private markets are protecting “paper unicorns,” says Lee, limiting short-term changes in valuation. Lee might have found 84 unicorns valued at a billion dollars or more but until the IPO or the buyout, no one knows how many of them are donkeys with fake horns.
Despite that rapid growth in the number of billion-dollar firms though, unicorns are still almost as rare as magic beans. Only one tech firm in 714 that received funding in the US over those ten years has grown into a unicorn, a rate, Lee notes, that is worse than catching a ball at a major league game but slightly better than being eaten by a shark.
But what can founders do to join them? How can they increase their chances of being as cool as Facebook—and should a billion-dollar valuation really be something they aim for?
How To Breed A Unicorn
First, it helps to be in the right field. Most of the companies that Lee found, and eight out of the ten most valuable companies, were consumer-oriented, although SaaS firms are also doing well. As Lee noted, they had also raised large amounts of private capital, and companies that used an ecommerce model contributed the most value to the unicorn club. Looking at the list of new unicorns that had grown up between 2005 and 2015, Lee found that they’re dominated by services that can fit onto the home page of a smartphone: Uber, Twitter, WhatsApp, Square. Enterprise-oriented unicorns (companies whose main customer is another business) were worth an average of $2.5 billion but that’s still less than half the value of the average consumer unicorn. An Uber for urban parking spaces has a better chance of being worth a billion dollars than software for the efficient management of parking lots.
Being in the right place will help as well. There are no surprises that the Bay Area is still the main breeding ground for mythical valuable beasts. Silicon Valley is responsible for 44 percent of all unicorn births. But according to Allen Miller, a high tech consultant at McKinsey, China, New York City and Europe are catching up. Both Boston and India have each produced three unicorns, with India’s three—Flibkart, SnapDeal and InstaCart—all operating in online retail.
Aileen Lee also found that nearly a third of the unicorns on her list had network effects; the product or service improved as more people used it. Facebook is only valuable because it has many users; Waze’s traffic reports are more accurate when the app is installed on lots of drivers’ phones.
And successful companies that grew into unicorns also tended to be founded by teams that had been together for a while, had clear product visions, good track records and included at least one technical founder.
So if you’re located in a tech hub and are producing a consumer-oriented, mobile product with large network effects and are working with a talented, experienced team of founders that includes a coder, you’re in with a shout. But there’s one more factor you’ll need: investors willing to believe that your idea will one day be worth a billion bucks. Only seventeen of Aileen Lee’s 84 unicorns had been taken public and only fourteen had been acquired. The remainder were still in private hands. Their status as unicorns depended entirely on investors’ belief that one day they’d justify that optimism.
That gives investors a great deal of power. The standard of success is now higher than ever. Unicorns that were born in the days of the dotcom boom—companies like Amazon and Google—promised returns that were astronomic in comparison to traditional companies but even they didn’t have to claim to be billion-dollar firms to win attention. Today’s entrepreneurs now understand that if they don’t get a billion-dollar valuation, they look like small-fry in comparison to the likes of Uber and WhatsApp. In an environment in which entrepreneurs have to either go big or go home, “big” has become almost unreachable, and the investors whose injections of cash set the valuations can make big demands to enable them to get there. Entrepreneurs now have to push harder and promise the near-undeliverable to win funds.
“It created a bubble and a mania over the last three to four years as entrepreneurs went crazy seeking to become unicorns,” says Sramana Mitra, a Silicon Valley entrepreneur and the founder of One Million By One Million, a global virtual accelerator that wants to help a million entrepreneurs reach a relatively modest million dollars in revenue. “They let investors stuff liquidation preferences into their term sheets and destroy their entire wealth-creating potential.”
Mitra cites the example of a company that raises $3 million in its series A funding round. Two years later, the series B brings in $50 million on revenues of $5 million and receives a billion-dollar valuation. It’s a unicorn. But hidden in the investment contract’s small print is a liquidation preference that requires the investors to receive a return of three times their investment, or $150 million, before anyone else is paid. Two years later, the company has quadrupled its revenues to $20 million and is bought out by Cisco for $120 million.
According to the terms of the unicorn investment contract, all of that money would go to the investors, leaving none for the founders after five years of work creating a nine-figure business. “Do not work for investors for five to ten years and end up making no money,” warns Mitra. “That’s not the point of entrepreneurship.”
Nor are the conditions that investors look for in unicorns suitable for many otherwise successful companies. Investors will only grant unicorn status to companies that can scale very quickly: from zero to $100 million within five to seven years, says Mitra. But matching product to the market can take time. Adam Singolda founded Taboola in 2007 but the company, which directs Internet users to related sites, had no revenues at all for its first four years. Singolda used that time to refine his predictive analysis technology. Once he had figured out how to pore over more than a thousand user signals to produce a recommendation, clickthroughs shot up and websites paid for the visitors. After four years of burning through an angel investment, Taboola hit $100 million in revenues in 2013. Revenues doubled the following year, and by the end of the year, the Israeli company had joined the unicorn club.
For Mitra, Taboola’s story is evidence that entrepreneurship needs to be seen as a marathon, not a sprint. High early valuations can damage the ability to grow for a company with large potential and while winning unicorn status early can be a badge of success, landing media attention and more injections of cash, it can also weaken the position of founders and move the company away from providing a service to customers and align it instead towards the goal of delivering set returns for VCs.
Far better, advises Mitra, to be capital efficient and focus on customers, revenues and profits. Instead of looking for VCs and angels who might accord magic unicorn status with a wave of their signing pen but take all of the money if a buyout comes in short, bootstrap first and take the time to figure out whether the product has market adoption velocity. Instead of going to a VC like a beggar in need of cash, entrepreneurs will be able to sit at the table with customers on their books and revenues ready for scaling.
“Raise small amounts of money, as needed,” says Mitra. “Avoid liquidation preferences. Preserve equity.”
That’s the strategy that worked for Zeta Global, a data and analytics firm. The company raised $140 million in April this year, bringing the total raised to $250 million and valuing the firm at a reported $1.3 billion. Even though the founders took far more money than they asked for, they still retained more than half the shares. What allowed them to hold onto the company were revenues of $300 million in 2016 and an annual growth rate of 50 percent.
The sudden success of a small number of outstanding companies in recent years has sparked imaginations in Silicon Valley and beyond. Traditional industries as varied as taxi cabs, hotels and automobiles have been unexpectedly disrupted by tech firms like Uber, AirBnB and Tesla that have moved off the Web to apply hi-tech solutions to the real world. It’s not surprising that both investors and entrepreneurs are wondering what other traditional industries are waiting to be upended, and how much that new world might be worth.
But those billion-dollar companies are called unicorns because they’re rare. There are also fewer of them than reports suggest. Not all of the firms that private investors have valued at a billion dollars are ever going to justify that valuation, so while the unicorn club might be prestigious to join, building a successful business that’s worth several million dollars is pretty cool too.
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