Here’s One Thing All the Billion-Dollar Unicorns Have in Common
They’re called unicorns — young companies valued at $1 billion or more — because at one point they were rare. Now, they’re much less so.
In the last two weeks the sector has seen several land large investments: Zenefits got a valuation of $4.5 billion, Pinterest hit $11 billion, Jawbone garnered $3 billion.
And now Uber, the ride-hailing service, is reported to be close to raising a $2 billion investment at a valuation that could reach as high as $50 billion or worth about as much as FedEx.
(Incidentally, the new word for startups valued above $10 billion, according to Re/code reporter Carmel DeAmicis, is decacorn.)
What’s going on here? How can so many startups achieve the coveted billion-dollar valuation status so readily when investors are supposed to be, by nature, conservative and inherently suspicious of risk? And, of course, is this kind of investing nuts?
A survey out Friday from the Silicon Valley law firm Fenwick and West gives us a pretty good clue. The firm advises a lot of these companies on its funding arrangements with investors — which are generally kept secret — and so it has a solid view into the makings of a unicorn. Fenwick analyzed 37 investments in privately held companies valued at $1 billion or more during the 12 months ended March 31.
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 in every one of these funding deals, the firm says, that in every case — all 37 of them — investors demanded a “liquidation preference.”
The phrase refers to language often found in an investment contract — and typical to most VC investments — that gives certain investors the right to get paid first ahead of other parties — such as founders or management — in the event the company is sold. If the company sells for a price that is lower than the valuation the investor paid, that investor is the first one in line to receive the proceeds of the sale until they’re made whole. And if the company sells for a higher price, they’re first in line to reap a share of the profit.
What that ultimately means is that the investors are taking on a very little risk when investing in unicorns, because they stand almost no risk of losing their money if the company goes south....MORE