Unicorns are like tennis courts. I would love to have a tennis court in my backyard. But my house is still great without it.
In the same vein, most everyone would love a unicorn (a startup with at least a $1 billion valuation) in their portfolio. But do you really need it?
The mainstream media thinks you do. It follows these $1 billion-valuated companies with the fervor of true believers. Here are some recent examples…
“Barring a major economic downturn or very poor showing by the venture-backed companies queuing up for their Wall Street debuts, it looks like 2019 could be another year where the unicorn herd swells” (Silicon Valley Business Journal).
“There are some 40 more fintech companies on the verge of reaching unicorn status… including companies like Stash, Betterment, Wealthfront and Lemonade” (TheStreet).
“In 2019 there are now hordes of unicorns in China, Silicon Valley and around the world… I can’t imagine how crazy things are going to get when the year’s IPOs [initial public offerings] actually start happening. It’s going to be even busier” (Crunchbase).
Here’s the conventional thinking on unicorn investing. Later is better than never. And earlier is better than later. These companies can make you rich or richer. It’s not just the ultimate prize, it’s the only prize you should be going after.
Here’s what I say: hogwash. Bagging a unicorn is great for bragging rights. But it’s not the only measure of success.
You can be an incredibly successful early-stage investor without a unicorn in your portfolio. The key is the valuations you invest at.
In our First Stage Investor portfolio, the last 15 seed-stage companies we’ve recommended (going back to 2017) have an average valuation of $7.1 million.
Now, don’t get me wrong. It would be great if one of these companies graduated to unicorn status. That would be a huge win. But our portfolio doesn’t need it.
Let’s do some quick math. A company with our portfolio’s average valuation exiting (via acquisition or IPO) at a $200 million valuation represents a little more than a 28X return (200 divided by 7.1), excluding dilution. When dilution is taken into account, gains would come to roughly half that, or 14X on average.
Our seed valuations range from $2.7 million to $22 million. Assuming a $200 million exit, our most expensive seed would still reward investors with a 4.5X return (including dilution). Our $2.7 million-valuated company would result in roughly 37X gains (including dilution).
If our $2.7 million company became a unicorn, gains would be 18,500% (185X), including dilution. That’s beyond great, of course, but there’s nothing wrong with a 3,700% (37X) return either. If you invested just $100 (investment minimums range from $50 to $1,000), you’d make $3,700.
And that’s the beauty of being a seed investor. You can invest in the next Uber and make a mint, just like a venture capital investor. But because you’re putting money into such low-priced shares, you can also invest in the next Super League Gaming and make an extremely generous profit. It has a capitalization of $91.7 million.
Or in MMTEC… it has a cap of $79.2 million. Or in Hoth Therapeutics… it has a cap of $52.8 million. Or in Equillium… it has a cap of $234.5 million.
All of these companies IPO’d in recent months. And all of them started off as small companies with equally small valuations, just like the companies in our First Stage Investor portfolio.
None of them came close to reaching the much-coveted unicorn level of $1 billion. But they didn’t have to for seed-stage investors to make a handsome profit.
What’s more, these market caps are much more common than a unicorn’s $1 billion valuation.
There are 315 unicorns today. That number is higher than the 131 recorded in 2015, but unicorns are still relatively rare.
Let’s go back to my $200 million exit valuation example. The Russell 2000 is the index for small cap companies in the U.S. Their caps range from $159.2 million to $5 billion. The median cap is $900 million, and $200 million is near the bottom of that range.
A $200 million exit is attainable. And again, using the average valuation of our portfolio companies, it would net us a 14X return (after dilution). That is still very much worth celebrating.
It’s not a really high bar for the company, but it qualifies as a huge win for seed-stage investors. And that’s a beautiful thing.
Co-Founder, Early Investing