There are unicorns on Wall Street? Indeed there are, but not the fictional beasts that are a favorite of pre-teen girls. As defined on Wall Street, unicorns are private companies that have valuations of over $1 billion. Generally, these are startups expected to create disruptive growth as they mature.
Continue Reading Below
There are well over 100 unicorns worldwide. A Wall Street Journal/Dow Jones analysis lists 130 companies, CNN Money counts 141, and TechCrunch lists 191 with 53 others listed as emerging unicorns. They include well-known names like Uber, Lyft, Airbnb, SpaceX, Snapchat, Pinterest, Square, BuzzFeed, Dropbox, Warby Parker, FanDuel, and DraftKings — but there are also many that you are unlikely to have heard of, such as the IT security company Zscaler, data management group Actifio, and Klarna, a Swedish payment service for online storefronts.
Since they are all private, the information that investors need to evaluate any unicorn's value properly is not always available — or credible when it is. Thus, unicorns can have tremendous evaluations built mostly on hype and expectations.
Investors can be faced with difficult choices. Are you looking at the next Facebook, which had a market value of $104 billion upon going public in 2012, but is worth approximately $350 billion now? Are you looking at Zynga of FarmVille and Words with Friends fame, which lost over half of its value within three years after its initial public offering (IPO)? It is simply not easy to tell.
The collective value of the 191 companies listed on the TechCrunch site is $716 billion with over $116 billion in raised funds. Even with such cash reserves (and in some cases, because of it), many of the unicorns have been delaying IPOs.
This article was provided by our partners at moneytips.com.
What Financial Advisors Say Are Your Biggest Investing Mistakes (Infographic)
IPOs 101 - How to Profit from Initial Public Offerings
The Difference Between Trading and Investing
Unicorns may become endangered if more of them do not start showing profits soon. Even Uber, with its massive $62-billion-plus valuation, will test investor's patience if it does not start showing signs of a profit in the next few years.
Cracks are starting to show in terms of pre-IPO devaluations. Dropbox and Snapchat have seen a nearly one-quarter drop in their pre-IPO valuations, while Square's pre-IPO value has dropped by approximately one-third. Larger investors and venture capitalists are sending a message to the unicorns: Outline a solid path to profits and start producing them soon, or expect your valuation to be slashed.
Diving ahead with an IPO is not necessarily the best path, either. Companies who have forged ahead with recent IPOs have not fared well. For example, global e-commerce marketplace Groupon is down around 78% since its IPO, and domestic issue Fitbit (NYSE: FIT) dropped 31% in the first half of November.
If you are considering investing in one of the unicorns that crosses over to public status via an IPO, be sure to read over the investment details carefully. Around 30% of the unicorns have so-called "ratchet clauses" that favor certain large and privileged investors. Ratchet clauses effectively reallocate additional shares to the privileged investors if the IPO price does not meet a pre-determined minimum value. This reduces the risk for special investors by diverting it to ordinary investors, who have their ownership shares diluted as a result.
It seems inevitable that the collective overvaluation will take down a sizable number of the current crop of unicorns, but those who survive are likely to provide great rewards. Don’t let the risks scare you away from investing in unicorns that you think will succeed, but make sure you understand the level of risk involved and can determine a proper pricing level.