What is a unicorn startup?
The phrase “unicorn” is thrown around a lot in Silicon Valley and beyond. It’s a kind of validator, a label that means your startup has made it. The idea was once a startup had hit a valuation of $1 billion, it had reached escape velocity and was on its way to massive success.
Here’s the thing: unicorns aren’t really unicorns anymore. Over time, valuations get larger and larger. Companies are taking longer to go public than they used to. And a $1 billion valuation isn’t necessarily a rare thing anymore — nor does it mean guaranteed success. It’s a lovely, big, round number that’ll look great on paper, but it means the work is just starting.
But since this is such a loaded term, let’s dive into a little bit about what it means to be a unicorn, and not just what the label is.
Where did the phrase “unicorn startup” come from?
The phrase “unicorn” goes back to a TechCrunch post circa 2012. Aileen Lee, the founder of Cowboy Ventures, coined the term to identify startups that had reached a $1 billion valuation or more. At the time, 39 companies belonged to Cowboy Ventures’ “unicorn club,” and around four unicorns came about per year.
Keep in mind, though, that this was in 2012. It was quite early in the lives of companies that would go on to become unicorns — and would take a very long time to go public. Oculus VR was born this year, while a handful of companies were just a few years old:
- Snap (2011)
- Zoom (2011)
- Pinterest (2010)
- Square (2009)
- Venmo (2009)
- Uber (2009)
- Asana (2008)
A whole lot of these companies have gone on to be substantial successes. But companies like Uber and Pinterest continued to accrue higher and higher valuations, and only went public earlier this year. Companies tend to stay private a whole lot longer, and as a result, pre-IPO valuations are getting much bigger. So being a “unicorn” isn’t quite as unique as it used to be — it’s more of a stepping stone on the way toward being a successful company.
What actually goes into a unicorn startup valuation?
You could say that as a founder, your valuation is a multiple of your performance, your future projections, your hopes and dreams, and then subtracted from that, reality.
All this more or less boils down to a multiple of your projected revenue assuming a “normalized” margin. For starters, you can look at public company multiples. These will vary from company to company (and you can just ignore the big ones). But while we might be in a little bit of a pocket universe where multiples get a little crazy, there are a couple of rough guidelines you can follow.
Next year’s revenue and profit
For SaaS companies, for example, this is usually a useful mechanism for determining a multiple to start your planning process. You’ll sometimes see SaaS companies valued at between 3 to 7 times next year’s revenue. That means you would take their annual recurring revenue (or ARR), multiply it by one of those, and you end up with a base multiple to get the process started. Different industries will have different revenue multiples typically tied to their valuations.
If you’re a hardware startup, you want to show you’re actually selling your hardware. If you offer a subscription service, people should be paying for that subscription. The more recurring revenue or sales you can show, the better (or more accurate) your revenue multiple is going to be.
Growth, engagement, and churn
If you are running a service that’s powered by eyeballs, just showing your user numbers going up isn’t going to be good enough. Your value is going to be determined by that user number, but also by how engaged those users are. That can be a mechanism of time spent on your service or the number of times they open an app, or that you have a minimal amount of churn. Separately, the demographics of the users are also relevant — as those with higher purchasing power are likely to be valued more richly.
A very non-scientific unicorn startup example
All of this is a lot to work out, so let’s walk through a very unscientific example with a ton of assumptions. Suppose I’m a completely fictional workplace communications startup that’s around three years old, with the following properties:
- I have an ARR of approximately $30 million, and I project my next year's sales to be around $100 million.
- I currently have around 1 million paying customers, and three tiers of a product: a free tier, a base tier, and a premium tier.
- I add around 50,000 paying customers per month, with a churn of around 1% (too many GIFs).
- I currently have a runway of about 15 months before I run out of cash.
- My overall user base grows by around 20% month-over-month, with a conversion rate of about 5% per month into paying customers.
So let’s get started at our revenue multiples. For comparison purposes, let’s look at Slack and Zoom. Slack is valued at $18 billion, while Zoom is valued at $24 billion. Slack generated $400 million in revenue for its fiscal 2019, and its revenue about doubles every year. Zoom generated around $330 million in revenue in fiscal 2019 and, again, about doubles in revenue.
So if we were to bake in some small, very unscientific slowdown, we could start with multiples on next year’s sales — let’s say an increase in around 60%. So where would this land us on multiples?
Slack: around 3x next year’s revenue
Zoom: around 4.5x next year’s revenue
So we already have a difference! This one’s pretty obvious, though: Zoom is turning a profit, while Slack isn’t. Slack lost around $140 million in 2019, while Zoom had a profit of about $7.5 million. We’ll already get a nice multiple on our revenue, with a small discount on our burn. So let’s be generous and say we get a 5x multiple, including burn, off our $100 million next year’s revenue. That gets me to a $500 million valuation.
But I'm an early stage company, so of course, I’m burning capital to grow. Hiring is expensive, customer acquisition is costly, and worst of all, I have to compete with Slack and Zoom. But I’m clearly growing substantially, and I seem to have an outside shot of taking part in the market. So let’s take a look at growth and runway.
I’ll have around 9x the number of users I have now in a year. Meanwhile, I’ll add about 600,000 paying customers, or 60% growth. I have around 15 months of runway — and obviously, there are levers I can pull to bring that down.
Now the mystery unicorn hand-waving might come in. Every investor, having seen hundreds (or thousands) of companies, will have some level of intuition on where you’re going backed up by data. You can look at the growth trajectories of something like Slack and Zoom at the stage they were in their lives, and clearly, there’s some historical value there. So, putting on our investor hat, we’ll wave our magic wand and grant another 4x multiple to the company for growth purposes.
Great! I’m a unicorn at a $2 billion valuation. Life, according to Hacker News, is fantastic.
Should I take a unicorn startup valuation?
All this being said, the previous example has a healthy 15 months of runway remaining. And it has paying customers and not a ton of churn — so it can probably extend its runway if necessary. It might even be able to pull the levers in such a way to be profitable! Why would it need some magic hand waving to prove it’s valuable?
Here is where we run into the question of being overvalued versus undervalued. But the real answer is that you should take money when the time and terms are right. Raising money at a $2 billion valuation while giving up 40% of the company, or dramatically diluting the value of the shares for your employees, probably isn’t a great idea. The last thing you want to do is to raise money in a panic and take whatever you can get.
But that kind of valuation does get you a lot of things if the terms and timing are right. It increases the value you’re creating for your employees, which can serve as a nice draw for talent. It also might give your future customers confidence that you aren’t going anywhere and you’re a good tool to use. Finally, having more money in the bank for growth or just for emergency purposes is usually a pretty good thing to have.