Venture Capital
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Table of ContentsAbstract        1Introduction        1Findings – Benefits of Not going Public        3Conclusion        6Abstract        This report discusses the implications of the rise in large private companies. These companies referred to as “unicorns”, given their previous rarity in the 2000s, use Venture Capital funds to grow. This is due to more and more companies not going public and ballooning valuations. Though not all Unicorns are discussed, the implications and concerns regarding these companies is universal. The outcome of this research is that currently there are minimal incentives for large private companies to go public and currently for many unicorns there is not a need. Based on recent Unicorn IPO’s, it is expected that there will be homeruns with high returns as well as flops where stocks fall from IPO price because of overvaluation. This leads to the assertion that until there are changes to the current funding models and increased regulation, it can be expected that there will be growth in the number of unicorns.IntroductionDue to the changing marketplace, there is a rise in “unicorns”, these are companies with over $1 Billion valuations that are private. Many of the venture capital funds and banks that have invested in these “unicorns” receive high returns exclusively once an investment goes public or is acquired. Therefore, we must consider the implications of Unicorn companies on VCs and future functionality of VCs. Furthermore, given that these unicorns are private their valuation are subjective, it is important to consider whether these unicorns could be overvalued and what is the impact of this. For startup companies, it is nearly impossible to access capital in the same way large corporations can; therefore, startups mostly raise money through different rounds of funding via Angel investors and Venture Capital funds. As Terence Channon who is the managing director of SaltMines Group states, Angel investors will typically “provide earlier stage dollars for a non-controlling stake” (Tech Insurance).Venture Capital funds are created through the pooling of limited partner’s capital into a fund. In 1193, the average fund size was $71M whereas in 2010 funds sizes were closer to $150M (Shane). It is expected that within the funds timeline, approximately 10-12 years (Industry Ventures), the general partners will invest in a variety of different companies and will receive returns from the investment following an M&A or IPO. The expectations are always favorable towards high returns though in venture capital results can be substantial loses or be huge successes (Sahlman 5). Venture capital firms take this risk into consideration when determining proper valuation, creating term sheets and considering investing. Venture Capital, not only supplies capital to help companies grow, but if a company is going to fail, it will fail faster with the injection of venture capital (De Massis 2). During the different rounds of funding, the company seek investments based on a valuation. Usually the valuation that the corporation comes up with will not match what the VC is willing to pay. For startups, there is no single method for valuation given there is so much future uncertainty and lack of information. Valuation is most often completed using the Discounted Cash Flows model, though cash flow information is not released to the public it is usually not completed for the valuation of Unicorns. Most frequently, valuations for startups are done using comparable analysis. This is usually completed by both the company and the VC with the company using an optimistic outlook and the VC utilizing a more pessimistic outlook. Then the final valuations for funding is a negotiation between the company and the VC numbers. A company can have many rounds of funding before going public though as noted by the Wall Street Journal, “Only public markets can judge whether these valuations are right. For now, its shoot and wish” (Kessler 2). Based on the final valuation for that round, the investor in return will receive an equity stake in the company. The expectation is that at some point, after a few rounds of funding, the company will go public or be acquired.
Some well-known unicorns as of January 2018 are Spotify, Dropbox, Pinterest and AirBnB. Forbes argues that “Many technology companies that remain on the sidelines are putting off an IPO in large part because theyre flush with money from private investors and can afford to do so…theyre happy to delay the rigmarole involved in putting together a public offering andbecoming accountable to investors” (Gensler  2). We see this is becoming more common, especially due to the 2012 JOBS act which increased the number of shareholders to 2,000, up from 500, before requiring a company to go public. Therefore, in many cases it isn’t required that a unicorn go public but at the discretion of the company.  As many VCs receive returns from their investment via IPOs and acquisitions therefore in the meantime there are limited returns for the VC. As more companies enter the Unicorn space, there is no definitive timeline for exit which leaves many of the returns and market questions unknown (Lathrop Gage).        Findings – Benefits of Not going PublicAs we see the increase in the number of unicorn companies, it is important to understand what are considered the benefits for not going public and how VCs are dealing with this. Private companies do not grow to the size of unicorns without venture capital investments but we are seeing that “for several years now, venture capitalists have been putting more into startups than they have been taking out in exits” (Kesseler 2). This can be attributed to the lack of IPOs and acquisitions which is limiting returns to VCs. For the private companies, there are many reasons justified for not going public such as the added “transparency and responsibility that [being public] entails” (Gensler 2). When a company is public, there is certain information, financials specifically, that must be released to the public which has effects on future valuations and share price in the marketplace. Additionally, there are litigation costs that have deterred private firms from going public (Zimmerman 60). Though not a barrier, this does not encourage Unicorn’s to go public given that the focus of startups is “Getting their products and services to the market quickly causes startups to search for strategic buyers rather than doing IPOs and using the capital raised to fund what is typically slower organic growth” (Zimmerman 60). We are seeing that current marketplace does not encourage or require Unicorn’s to go public.