The Power of Myth: Investing in Unicorns

Welcome to the October 2019 edition of our newsletter!  In this issue, we’ll examine the risks and rewards of investing in “unicorns”, and look at some ways to better understand the risks in advance.

The Danger of Unicorns: When Entrepreneurial Spirit Can Haunt Investors

A recent trend in private equity is the growth of so-called “unicorns” – technology companies seen to have a disruptive product or service, or some other distinctive niche, which could lead to market dominance for that sphere over time.  Typically, these startups have valuations over $1 billion, and recent examples include several ride- and office or home-sharing companies.

The temptation for investors is obvious: who wouldn’t want to ride a decade-long (or longer) wave of dominance in a sector before others inevitably caught up to the disruptor’s model?  The risks are usually less obvious, although headlines about the failed initial public offerings of some unicorns have made them more pronounced.  Valuation as a private company can be very different than when a company seeks to enter a public market, and often Wall Street estimates of what a company is worth can be less than sound, as conventional actors (Wall Street analysts) try to fully understand unconventional goods or services.   Additionally, investing in a pre-IPO unicorn ties up an investor’s money for a longer period of time, and as importantly minority investors are not empowered, generally speaking, to challenge the existing leadership, which often includes a founder (or founders) who has a vision which they are seeking to execute – and which they may resist altering in the face of changing circumstances.

One way to research the viability of a unicorn is to take a close look at the company’s management.  Sure, the technology may be new and innovative, but what are the track records of the people who are embracing it?  Did they innovate in similar ways at prior employers, and if so, what results did they achieve, or fail to achieve?  Do they have a record of litigation and public comments that might herald difficulty working with larger group as a company hopefully grows, or did they have a record of getting the best work out of subordinates?  If they have started other companies in the past, what was their track record, both in terms of obtaining financing and bringing products to market?

Another aspect to consider is where they’re obtaining their existing financing from.  If a large institutional investor has made an investment, they’re likely to have commented about in some form, and those comments should be parsed carefully for red flags couched as cautionary statements – risk that may be “cautionary” to a billion-dollar investor could be devastating to your client.   By thoroughly evaluating the potential risks in the business model, market and personnel, you can help your client reach mythical heights instead of seeing returns vanish as if they never really existed.