A Unicorn or a Double

One of the hot words in the startup press today is “Unicorns”. Unicorns are private companies with a value of more than $1 billion such as Uber, Snapchat and Dropbox. Many recent news articles are somewhat critical of the growing list of unicorns, many of which are unprofitable. Some articles raise concerns with the potential of a bubble in the valuation of these unicorns. Regardless if there is in fact a bubble, the existence of so many unicorns can lead to institutional investors getting overly focused on investing in baby unicorns.

A friend of mine recently gave me an update on a startup that he has been mentoring. It’s a neat little startup with a young management team, a cool consumer product a nice track record of initial sales. But for the moment it is a one product company, and that product has some unique features but it is not highly protectable, despite one or two patent filings. I could see the company hitting $5 million in sales, and maybe generating $2 million a year in profits without needing a large investment. If the founders ran it for 5 years with continued growth in sales and then sold it for 3 or 4 times EBITA, they would be in a great position to pursue their next idea. I would call that a solid “double”, as in a moderate but not huge success.

But, that’s not the path they are on. They got involved with a Silicon Valley incubator type program. Kudos to them for getting accepted (although there are some strings attached). But now my friend tells me that they have been introduced to VCs out there who are telling them that they have to show how this can become a $1 billion company – a unicorn. That worries me. These young guys are getting caught up in the legitimately exciting atmosphere of the Valley. And I really don’t think they have a baby unicorn. But with enough prompting they may come up with the billion dollar story, start believing it themselves and get an investment from a VC who has cash to burn and is desperate to find a unicorn.

Then maybe they prove me wrong. But if they do become a billion dollar private company, I hope they are profitable, unlike so many unicorns. But what I’m afraid will happen is they will get $20 million or $30 million in investment and then in a few years fail to show adequate growth and the investors won’t allow a modest exit. Rather, they will force them to keep burning through cash until they finally go bankrupt. Now these young entrepreneurs will have received a hard education and come good contacts, but have little else to show for the years of stress. I makes me wonder. Wouldn’t a good clean double be better than chasing a unicorn?