1Mby1M Virtual Accelerator Investor Forum: With Mackey Craven of OpenView Venture Partners (Part 5)

Sramana Mitra: How do you parse unicorn mania?

Mackey Craven: By unicorn mania, do you mean the number of companies that have billion-dollar plus valuations that are still private?

Sramana Mitra: A lot of things. There’s unicorn mania in that there’s so much capital. There is a rush to fund these later stage companies and overfund these later stage companies. Last year, we did an extensive coverage of a phenomenon. It’s a unicorn mania negative phenomenon called Death by Overfunding. These were very good companies.

They could have been fine companies if they were modestly financed, but they just completely went crazy and went ahead of themselves and basically imploded. That’s one part of the unicorn mania. The other part of the unicorn mania is this absurd liquidation preferences to create a valuation that hits billion-dollar valuations. Entrepreneurs get carried away by that.

There’s a series of unhealthy behavioral practices that has developed around unicorn mania. To be fair, there’s a lot more awareness around this issue. The phenomenon has slowed down a bit. I’m just curious how you observe it. What are your comments?

Mackey Craven: It’s something I’ve thought a lot about. In 2015, I wrote an article in Tech Crunch about exactly this with some of the same points saying, “Let’s look at the data and try to understand what’s driving these astronomical valuations and why are companies raising more and more capital in later stages without going public.”

What we saw was while the amount of capital, in general, raised by growth equity or very late stage ventures hadn’t really changed from 2005 to 2014, the number of funds raising that capital roughly halved. What you had was a situation where, on average, fund sizes grew by almost 100%. The media deal size for a growth investment went from roughly $11 million to a little over $20 million.

Because the fund is twice as big and they don’t have twice as many partners, the investment size doubles and you also saw in the same period that the median pre-money valuation doubled. As a result, there was a very strong cycle of private capital. You had larger funds which ultimately allowed these GPs to earn higher management fees. Entrepreneurs can raise more money and hire more aggressively and burn more.

Ultimately, it reduces flexibility substantially. You can either get acquired for a very high price. The frequency or the number of tech acquisitions over a billion or over $200 million hasn’t changed dramatically. Your other option is to go public. However, if you raise substantially more money to get to the same revenue scale as prior years, there are some that would burn heavily. They would then look at the valuation difference between their recent private marks and how the public market would fundamentally value them. Some have crossed that gap, but most haven’t.

Option three is staying private and working to reach profitability. That’s the path that most of these companies have taken. It’s a hard path. The fourth is flame out. For those that are unable to get to profitability or at least get to a point where their investors and management teams are comfortable going public, they get stuck. Unlike the end of the bubble in the early 2000’s, there isn’t going to be a moment of reckoning. We’re in a long drawn out process where these companies will come back to earth.

Sramana Mitra: Yes, because venture capital has a very long cycle. These bloated funds will continue to be bloated for a long time. You’re talking about a decade before any adjustment takes place.

Mackey Craven: They’re still raising large funds. You can see a handful of growth funds continuing to raise at record levels.

Sramana Mitra: Then there is the outlier which is SoftBank. It seems like all the somewhat dysfunctional lower-funded companies are going to eventually end up in the arms of SoftBank.

Mackey Craven: We’ll see what they’ll do.

Sramana Mitra: SoftBank is still investing in these hyper-large rounds even in companies that are showing somewhat dysfunctional statistics. They may be doing down rounds but they’re taking this as an opportunity to get into companies that have some level of success but are now reaching a plateau and are overfunded. I see that phenomenon happening as well. It’s an interesting trajectory of these unicorn companies that are not entirely healthy.

Mackey Craven: There’s a subset of them. Many are fantastic businesses and will continue to be. There’s a universe of those that are. There’s a universe of those that are but continue to raise in the private markets. There’s a set that have some serious challenges. It’s hard to make a statement across the overall herd of unicorns and certainly can’t speak for the vast majority. But I agree. If you look at the math of the amount of capital raised and the number of acquisitions, there’s an equation there.

Sramana Mitra: That was an excellent discussion. Thank you for sharing your perspective.

This segment is part 5 in the series : 1Mby1M Virtual Accelerator Investor Forum: With Mackey Craven of OpenView Venture Partners
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