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The Funny Money Unicorn Business

Posted on Wednesday, May 13th 2015

For those who follow my writings on Billion Dollar Unicorns, you know that I am not a fan of ‘Valuation Without Revenue‘ Unicorns. The mindless inflow of capital into companies with dubious monetization ability irritates me. This week, some important coverage has emerged on the games VCs are playing to achieve Unicorn status for their portfolio companies. The most important, must-read piece on the subject is from Heidi Roizen, Operating Partner at DFJ: How to Build a Unicorn From Scratch – and Walk Away with Nothing.

Arik Hesseldahl at Re/Code writes in Here’s One Thing All the Billion-Dollar Unicorns Have in Common:

It turns out that for companies of a certain size, it’s not that hard to get to unicorn status, provided they’re willing to give their investors a lot of assurances that essentially cover their potential losses. The one thing common to every one of these funding deals, the firm says, is that in every case — all 37 of them — investors demanded a “liquidation preference.”

What that ultimately means is the investors are taking on very little risk when investing in unicorns, because they stand almost no risk of losing their money if the company goes south.

Of course, these investments are a gamble that investors make to get more money back, either by way of a public offering or selling at a higher price.

And not all IPOs pay off as handsomely as expected. BoxNew Relic and Hortonworks all debuted on public markets at valuations lower than they commanded during their private rounds. Only about 20 percent of the time did investors demand protection against that outcome with what’s called a senior liquidation preference: The investors get paid not only before common investors, but also before those holding preferred stock.

An even smaller percentage of investors in those deals — 16 percent — demanded a minimum IPO price that was at least as high as the valuation they paid, while 14 percent demanded additional shares if the IPO price was lower.

My earlier piece, Why Not All Private Unicorns will become Public Unicorns and my analysis of the Box IPO discussed this phenomenon as well.

Heidi asks the right question:

Understand your own motivation: What are you doing this for? So you can see your face on the cover of Forbes? So you can have thousands of employees working for you? So you can be a member of the billion dollar Unicorn Club? Perhaps it is to do something you are personally excited about and in a reasonable amount of time, maybe take enough money off the table to live in a nice home, pay for your kid’s college and your retirement. I’m not saying one is more correct than the other, I’m just saying that your own goals will dictate whether you should even raise venture at all, how much to raise, and what to spend it on. If you raise $5 million and sell your company for $30 million, it will likely be a life-changing return for you. If you raise $30 million and then sell your company for $30 million, you’ll end up like Richard.

I will stretch Heidi’s point of view and offer my take on the topic as follows:

  • Do not become a pawn in the hands of VCs so that they can claim a Unicorn logo for their portfolio. [Read: The Commoditization of Venture Capital]
  • Do not get led astray by VCs wanting to shower you with financing at gargantuan valuations. Ultimately, entrepreneurs and investors make more money with a capital-efficient strategy, except if an outlier like Google or Facebook is on the table. Most ventures are not Googles and Facebooks. Avoid letting investors delude you. Avoid deluding yourselves.
  • Your goal as an entrepreneur, if you’re going to invest a lot of years of your life in building a company, is to make money for yourself, your team, and your investors. NOT being a member of the Unicorn Club. 
  • If you take investors’ money and don’t provide return on investment, they will not give you money for your next venture. And if you yourself have not made money this time round, you will be looking to try your hand again.

The market is currently not just frothy, it is utterly stupid. There is a lot of funny money business going on. If you let yourself get sucked into this game and lose sight of the ultimate destination, you can cry yourself a river later, but there is no going back.

Game over. Years of your life written off in one clean stroke. Dreams go poof!

Finally, there are numerous ‘legitimate’ Unicorns that we have covered here, as well as in my recent book, Billion Dollar Unicorns. They all have one simple thing in common: they all generate serious revenues and have a scalable monetization model. Remember, Entrepreneurship = (Customers + Revenues + Profits); Financing, Valuation, Exit are all optional tools.

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