Joining billion dollar club is a decision to go public

The private financing market is favorable.  So much so that we now have Facebook pages set up to count and follow the unicorns – venture-backed companies that have raised capital at valuations above a billion dollars.  This is not a bad thing.  It means the private market has the depth to finance a company on attractive terms for as long as the Board decides the company should stay private.

However, the expansion of available private company valuations has implications a Board and a CEO should consider when pricing the next round.  A big step up in valuation means the collective team – leadership, employees and existing investors – are signing up to produce a much bigger outcome.

Late stage venture investors often price investments with a goal of generating a return of about 3x invested capital over three years.  Crossover investors like T. Rowe Price have slightly different benchmarks, but not that far below the venture investors.  These mutual funds crossing into private company investing are taking risk with illiquid investments with the expectation these comparatively small positions will materially outperform the fund’s large public equity holdings.  A base unicorn valuation of $1 billion going in to an investment means late-stage investors expect to exit at a value of about $3 billion.

Who is available to provide investor liquidity at that price? The first group is corporate acquirers with an enterprise value at least 4x the value of the acquired business or about $12 billion. There are 5,730 publicly listed technology companies in the world. 82 of those, or 1.4%, pass the capacity threshold.  32 of these 82 are semiconductor / electronics manufacturing companies that tend not to be frequent buyers of venture-backed start-ups.  This leaves about 50 likely corporate buyers across the full remaining span of the tech industry. The second group of buyers includes private equity firms comfortable with the technology sector that can write an equity check of at least a billion, suggesting a fund size of at least $10 billion. That group adds about a dozen possible buyers with Hellman & Friedman recently joining the club of Bain, Silver Lake, Thoma Bravo, TPG, Advent, Carlyle, Vista, Blackstone, etc.

Boards should understand when evaluating a late-stage financing that the global unicorn buyer population totals perhaps 65 – 70 entities. This group has executed 72 tech sector purchases of $3 billion or more in the past ten years. Looking to these potential buyers as the primary source of future liquidity is a bet that your company will exit in what is statistically about one deal each of these buyers does every ten years.

There are buyers in the required weight class: eight M&A transactions above $3 billion have been announced already this year.  The consolidators in our sector have strong balance sheets, often fallow internal R&D efforts to produce new product pipelines and a strong bias toward using corporate cash for M&A rather than dividends. However, a robust private valuation begins to change the required investor exit map.  Boards should be fully aware that when the company’s private market value reaches unicorn land it now exceeds the enterprise value of 88% of all publicly listed tech companies and M&A options begin to narrow.

When you take capital above a $500M valuation, you are implicitly deciding that an IPO is the most probable event for your existing investors.  That is a perfectly rational decision, but one that should be taken intentionally rather than just incidentally because capital is available at a good price.  Joining the unicorn club is best done once you have conviction that your addressable market size, sustainable competitive advantage, customer acquisition model and unit economics all add up to a future independent public company.