22Jun 2016

Peter Denious

Head of Global Venture Capital

Unicorns face a new reality

Unicorns face a new reality

Falling valuations in private markets starting in the latter part of 2015 and continuing into early 2016 have set off a shift in the way late-stage venture-backed companies are operating—in a good way.

Until recently, so-called unicorns could raise nearly endless amounts of capital at highly attractive valuations. In fact, in many instances, late-stage private market valuations exceeded subsequent public market valuations, as investors bet that these companies would grow into those premium values. Meanwhile, the availability and low cost of capital allowed companies to continue to finance their growth plans while remaining private and independent. Top line growth was first priority, while profitability and, in some cases, operational discipline, took a back seat.

Private Company Median Valuations

Source: CooleyGO

Since the correction, however, some of the most active late stage/pre-IPO investors have become far more valuation sensitive or have retreated from the market altogether. We continue to see a very small number of unicorns that are able to raise money at lofty valuations, but we see this as a “flight-to-quality,” as investors seek out only the most disruptive and proven of the unicorn herd. These are now the exception, not the rule, as most unicorns will have a very hard time maintaining their last round valuation.

Investors are seeking out only the most disruptive and proven of the unicorn herd.

Now that valuations are falling for all but a few, unicorns which were not already profitable (the vast majority of the ~150+) are racing to demonstrate the profit potential of their business model – or better yet, to actually achieve profitability. Many of these companies have raised enormous piles of cash—proverbial war chests—to finance this mad dash to profitability, so the inevitable thinning of the herd will take some time.

Several missteps at high-profile companies of late have also fueled VCs' and entrepreneurs' renewed focus on operational discipline. Many private, venture-backed companies have become quite large and complex, operating in highly dynamic, occasionally regulated industries, so the newfound focus is overdue and entirely appropriate. A more rational late stage market, driven by business model fundamentals, makes for a more sustainable long-term venture capital ecosystem.

Securing unicorn status is not a guarantee of success

In the meantime, the falling costs of technology continue to fuel an exciting cycle of innovation. Many non-tech segments of the economy are only just beginning to be disrupted by technology (education, healthcare, transportation, to name a few) while advancements in artificial intelligence, machine learning, and virtual reality continue to open new avenues of exploration. We have no doubt that the next generation of unicorns will be just as transformative as the current generation.

Important Information

Among the risks presented by private equity investing are substantial commitment requirements, credit risk, lack of liquidity, fees associated with investing, lack of control over investments and or governance, investment risks, leverage and tax considerations. Private equity investments can also be affected by environmental conditions / events, political and economic developments, taxes and other government regulations.

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