Did you ever see a unicorn? We didn’t (at least not consciously). A unicorn in the startup world is a company which value has reached a billion dollar. In the tech world, few succeed and many fail. When a company is worth a $1bn and you did participate in its last round, you really (really, really) want it to succeed. First, at that price, you need to invest a lot of money for you to have more than a fraction of the company. Then, if everything doesn’t go as planned, its value goes down faster than the thunder in summer.
Today, there are more unicorns than ever before. People have been pouring millions of dollars in companies to be part of the gold rush. With current interest rates at a historical low, investors have been looking to get involved with the next Facebook and bring back to their investors nice little numbers. The problem? there aren’t so many Facebook around…
Some companies which have such a high price tag are clearly worth it. They have strong and consistent growth, an important revenue base and profitable prospects. But many on the land of the unicorns aren’t like this and the rider might soon go back to ponyland.
One of the last example to date is Gilt according to the WSJ. The flash sales website which was valued at more than $600M dollar on its last financing round in February, is on the verge to be sold for less than $300M (the current number seems to be around $250M). This would mean that its value has been divided by 2 in less than a year. Ouch…
But what happened to this baby unicorn? It appears that Gilt had an operating loss of $11M in Q3 2015 and is not yet profitable. Can you imagine? Buying or investing in a company at a $600M price tag when it still loses money? This hardly makes sense and it seems that it won’t make sense at all in the coming months when Mr. market decides otherwise. It’s true that many startups that have such a valuation or more are still umprofitable and remain excellent investment (there are always exceptions). Experienced investors can see that as soon as those companies will put some monetization mechanisms in place, they could and should make tons of money. They don’t create value only because of the hype surrounding them.
In the other hand, a company like Gilt, like so many others, cannot really reinvest itself from one day to the other. Its model is clear and its operations have mostly been the same for many years. What in the world will change for it to suddenly become our next Facebook and to start generating sufficient cash to justify its present (or past) valuation?
A down round is very bad. Not only it kills the morale of the employees and the management team, it creates huge problems with current shareholders. Because of the complexity of most venture agreements which include many special rights (e.g. full ratchet), the cap table is prone to move in unexpected ways as soon as you don’t continue to push the price per share higher. This is why it is always important to place the bar of your valuation on something coherent. If it is very high, you might be happy for a time. But if you don’t deliver the forecasted results with perfect timing, the next round could be disastrous for the company. And as you know, it’s really hard to forecast growth in a startup.
With current market situation and the gentle but certain reduction of cash available for mega rounds, the number of unicorns which have grown too quickly, without all the necessary fundamentals in place is bound to explode. And when it does, even the small companies which have a compelling story will suffer has everyone always follows the same train.
We will try to think differently and judge a company for what it is and for what it can offer before placing a price tag. We believe that it is in down turn, when the excitement is lower and the time to think and then execute is longer and cheaper, that some marvelous unicorns might be flying in the sky.