August 23, 2023 • 30 mins
In 2013, venture capitalist Aileen Lee coined the term "unicorn" for startups. What makes a startup a unicorn? How rare are they? And how do investors assign value to a company that might not actually do anything?
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Speaker 1 (00:04):
Welcome to Tech Stuff, a production from iHeartRadio. Hey thereon
Welcome to Tech Stuff. I'm your host, Jonathan Strickland. I'm
an executive producer with iHeartRadio and how the tech are
you so. A decade ago, an investor named Aileen Lee,
(00:25):
the founder of a venture capital firm called Cowboy Ventures, which,
like crap, that's a great name. She coined the term
unicorn to describe a startup that has reached the unbelievable
milestone of a billion dollar valuation, and since then, tech
(00:46):
boffins have used the term unicorn to single out startups
that stand out from among the crowd. Every startup founder
is hoping for a unicorn. In fact, every investor is
hoping that they get in on the ground floor of
supporting a unicorn. The end goal for most investors is
(01:07):
to sink a decent investment in a startup, see that
startup climb and valuation to astronomical heights, and then rake
in the wealth when that company inevitably goes public. That's
the dream scenario. You see this huge return on your investment.
In fact, there are venture capital firms that really count
on a few of the companies they pick reaching a
(01:31):
level of unicorn status because it pretty much carries the
entire company. It'll help carry and balance out all the
ones that didn't really reach those levels. What's interesting to
me is that there's no point in this journey toward
billion dollar valuation where a startup actually needs to make
(01:53):
a profit. Startups can reach a billion dollar valuation without
making a profit. They could potentially make it without even
having a plan to reach profitability, although that's less likely.
Typically they will be at a point where they're generating revenue,
but they're not making more than what they're spending, so
they're still operating at a loss. So as an example
(02:15):
of this, I'll give you a unicorn example. The former
Twitter now X originally reached a billion dollar valuation back
in two thousand and nine, but Twitter didn't turn an
annual profit until two thousand and eighteen. Nine years later,
it was worth a billion dollars but had not yet
(02:38):
made an annual profit. It did make a quarterly profit
a couple of times before twenty eighteen, but the first
time it made a profit at the end of a
year was twenty eighteen. Crazy, So profits are not really
a necessity when it comes to achieving unicorn status. It's
certainly not a necessity for making a boatload of money
(02:58):
off of a company. Now, that was not always the case, right.
Once upon a time, investors were much fewer and further between.
It was harder to get hold of investment capital. So
for a business to really survive, it had to make
a profit, or at the very least, it had to
break even. Otherwise there was no way to cover the
(03:19):
costs of operation, and you would you run yourself out
of business. It'd be too expensive to run the business
to stay in business, and any hope of becoming an
enormous success really hinged upon being profitable. But let's put
that aside for a little bit. Let's get back to
talking about unicorns. So in twenty thirteen, Aileenlye writes a
(03:41):
piece titled Welcome to the Unicorn Club. Learning from billion
dollar Startups, and Lee called these billion dollars startups unicorns
because of their rarity. They were so incredibly rare. According
to her company's research, out of the thousands of companies
that had been launched in the previous decade from two
(04:03):
thousand and three to twenty thirteen, only point zero seven
percent of them reached a billion dollar valuation. I want
to say it was like thirty nine companies at the time.
So that raises a question, what exactly is valuation? How
do analysts determine or really, if we want to be accurate,
(04:27):
how do they estimate the value of a startup, especially
a startup that may not have a product to sell. Now,
with publicly traded companies, one way to measure value is
through market capitalization. This is a pretty simple concept, really,
So publicly traded companies have shares. Right, you can purchase
(04:50):
a share in the company. Each share is worth a
certain amount, and that amount is determined by the market. Now,
going into all the different forces that play into the
the share value of a company would go well beyond
my meager ability to explain. If I could explain all
of that in great detail, I would be in a
different tax bracket. But essentially, for market capitalization, you take
(05:16):
the number of shares that are outstanding the ones that exist,
in other words, and you multiply that number of shares
by the value per share. Then you get the market
capitalization of a company. So we'll use an overly simplified
hypothetical example. Let's say we've got a company and we're
calling it Willie's Widget Wonderland. It's a publicly traded company,
(05:38):
and the shares for Willy's Widget Wonderland are trading at
ten dollars per share. So for ten American dollars, you
can buy yourself a single share in this company. Let's
also say that there are only one hundred thousand shares
of this company at all, that's all that exists. Well,
we would then multiply these two numbers together, right, ten
(05:59):
dollars per share, one hundred thousand shares. That gives us
a million dollars. Boom, that's the market cap for Willie's
Widget Wonderland. Now, like valuation, market cap doesn't rely on
stuff like profit or revenue, at least not directly. Those
factors can play into the value of the company by
(06:21):
affecting the company's stock value, and that in turn does
affect market capitalization. So market cap tells us what the market,
the stock market in this case, values a company at.
Often investors will reference marketcap as the size of the company. Now, technically,
market cap doesn't indicate if a company is, you know,
(06:43):
physically larger or smaller than any other company, but rather
the size of its value in the marketplace. However, typically
larger cap companies are more established, and usually that means
they are also more stable than companies that have a
smaller market cap. But you know, to talk about the
(07:06):
value of a company beyond just the measure of market cap,
you have to talk about all sorts of other stuff,
like you might have to take into account how much
revenue the business generates, what are its costs of operation,
how much does it pay in taxes? You know, how
much of the business has depreciated over time, and by
how much. This kind of gets us into the dreaded
(07:28):
EBITDA or EBITA as I've heard it said that actually
it's eb I t DA. It stands for earnings before interest, taxes,
depreciation and amortization, And y'all, I have been in meetings
where EBEDA is part of the discussion, and every time
it happens, I can feel my eyes start to glaze over.
(07:52):
I will say that there are critics who have argued
that EBEDA has been misused, that companies have leaned on
EBEDA to perhaps overstate their profitability because it does take
a lot of costs out of that equation, and that
it's really just a way for companies to make it
seem like they're doing a lot better than perhaps how
(08:13):
they are really doing once you take all of these
different factors into consideration. But to get into it further
would mean we'd need to find another host because I
would fall asleep. And anyway, we're not really talking about
publicly traded companies, are we We're talking startups. So a
startup typically is a privately held company, a corporation. It
(08:33):
usually has the goal of becoming a publicly traded company
at some point in the future. It's not necessarily its goal,
but often that is the understanding among both the startup
itself and its investors. So how the heck do you
assign value to an entity like that. It's not a
(08:54):
business that's established, that has a history, that has actual
spreadsheet showing things like costs versus revenue. How do you
put a value on a startup that, perhaps in its
earliest stage, is very little more than just a good idea,
or hopefully a good idea. And that's a really good question.
(09:15):
So let's imagine that we have a brand new startup
and the founders have, you know, an interesting idea, but
at the start, they don't actually have a product to sell.
There's no operating income for the business. Maybe they've got
a company structure, like maybe they've designated officers for the
business who are in charge of specific functions, but as
(09:36):
of right now, they're not yet producing something that they
can sell. How do you place a value on that
kind of operation? But hold on, it gets even more
complicated than that. Let's say that this startup is a
really new idea, like it's really innovative, something that hasn't
seen much or perhaps any representation in the market as
(09:59):
of right now. Now, well, that makes it even harder
because it means you have very little you can compare
that startup against in the market, So that becomes a
barrier to valuation. You can't say, oh, well, this other
company is valued at such and such, so that's probably
the ballpark where we need to look at for this
other startup. If the two startups are nothing alike, then
(10:19):
there's no reason to port over that value from company
A to company B. On top of that, the market
changes quickly, which makes it really hard to predict how
the startup is going to perform in the future. So
will the market continue to support this startups business model
and thus lead to enormous growth, which is what all
(10:41):
the parties involved want to see. Or will the market
itself change and thus the business model then becomes irrelevant.
It's not that the business model was bad, it's just
it no longer applies because the market itself has changed.
Or will it turn out that the market demand for
the company's product just isn't there, like you think it's
(11:01):
there because it sounds like a great idea, but once
you actually get it out there, no one really seems
jazzed about it. Here this reminds me kind of of
how I see the metaverse right now. Obviously, the metaverse
itself is not a startup, but the fact that I
often see a lack of enthusiasm in the general public
around the concept of the metaverse makes me question the
(11:22):
wisdom of investing billions of dollars into that idea. So
the truth of the matter is that lots of factors,
some of them subjective ones, will come into play to
determine a startup's value, and they can include things like
investor opinions. If investors are enthusiastic about a startup, that
startups valuation typically goes up. But other stuff involves things
(11:46):
like market trends or assumptions about the market in general.
So it gets very whibly wobbly. We're going to take
a quick break. When we come back, I'm going to
talk about some approaches toward assigning value to startups. Okay,
(12:08):
we're back. So, as I mentioned, there are a couple
of different ways that investors will attempt to assign value
to a startup, which will ultimately determine whether a startup
reaches Unicorn status. One of those ways is called the
market multiple approach. So broadly speaking, this method takes a
look at recent acquisitions in whatever sector the startup is in.
(12:33):
So if the startup is at all similar to other
businesses that are part of these acquisitions, this is a
good approach, or at least a viable one. So what
you do is you look at the acquisitions that have
been made. You also take a look at how much
those businesses, those startups that got acquired, how much were
they making in sales or how much sales were they
(12:53):
actually seeing at the time of acquisition, And then how
much of a multiplayer is there for the amount of
sales versus the amount that was paid for at acquisition.
That gives you your market multiple. So let's talk about
our fictional widget company again. Let's imagine the widget company
is not publicly traded, it's a startup. And let's say
(13:16):
that investors look at how much other companies are paying
to acquire hardware companies that are in some way similar
to this widget company, and it turns out the acquisition
price is about six times greater than the actual sales
that these companies are making. That that's the average that
you're seeing across these acquisitions six times more. So your
(13:36):
market multiple is six and you can use that multiple
to kind of estimate your own company's valuation, though obviously
you're going to have to tweak that depending upon the
status of your own startup. So for example, if you
haven't really built out manufacturing facilities yet and you don't
actually have anything to sell, well, you can't really multiply anything.
(13:57):
If you're at very low scale then and maybe your
multiple is much lower because you haven't proven that you
can scale the business up yet, and that means that
investors are taking on a greater amount of risk when
they invest in your company. So your multiple ends up
being smaller than the market six times multiple that you're
(14:18):
seeing elsewhere. But this can be a way to kind
of guide you toward valuation. Obviously, the big hurdle here
is that the market multiple approach is dependent upon finding
comparable businesses in the market that have been acquired. If
your startup is really innovative and really doesn't resemble other
(14:38):
stuff that's already on the market, then you don't have
anything to compare it against. You don't have any way
to derive the multiple in the first place, because there's
no one else out there that's like you. So you
can't depend upon what's happening in other parts of the
market because it may not have any application toward your situation. However,
there are other means to assign valuation. So another is
(15:00):
called the cost to duplicate. This is pretty self explanatory.
How much money would it take to build a duplicate
copy of the startup in question. Now, actually coming up
with that figure can be a little tricky because it
can involve stuff that's a little more ephemeral than just
how much do the facilities cost? How much is the
(15:21):
business paying its staff, like how much is not just
rent but the cost of operations. It can actually include
other stuff too, like intellectual property that becomes harder to
put an actual, like monetary value to and that gets
a bit wishy washy, or things like the value of
(15:43):
research and development that's going on within the startup. How
do you put a monetary value on that. So the
cost to duplicate has a pretty big drawback. It gives
a snapshot of a company's current value, but it doesn't
necessarily take all of its assets into account because not
all of them are so easily reduced to a figure,
(16:04):
and it cannot bring into account the potential for the
company's success. Right It's looking at a snapshot of why
it's valued right now, but it's not telling you what
will it be valued six months from now, assuming that
everything's working well. So there are assets that just might
not be quantifiable, but they are still valuable to the organization,
(16:26):
but they're not going to show up on a spreadsheet
because he can't reduce it down to that data point.
For that reason, the cost to duplicate method can undervalue
a startup, sometimes by a significant amount. So you could say, like,
all right, well this is the low ball range of
the company's valuation. That would be a safer thing to say,
because you are acknowledging that this cost to duplicate method
(16:50):
does not take all assets into account because it just
it's not designed to be able to do that. Next up,
we've got the discounted cash flow method, or DCF method,
and in some ways it's kind of the opposite of
the cost to duplicate approach, because it's all about looking
forward as opposed to getting a snapshot of current value.
(17:13):
The DCF method requires analysts to predict how much cash
flow a startup will have in the future, and then
also bring into account the expected return on investment that
the startup is going to create, and putting those together
tells you how much that cash flow itself is worth,
and that ends up allowing you to place a valuation
on the company. To me this method comes across a
(17:36):
lot like telling fortunes. You're making the best guess you
can based upon the information that's currently available, but knowing
how things can change quickly means that at some level
you really have to acknowledge that this approach is far
from bulletproof. The last method can sometimes feel the most
arbitrary of them all. It's called the valuation by stage method,
(17:58):
So this method assigns value based upon how far along
the startup is as it develops to become a real boy. Wait,
I'm sorry, No, I'm sorry, that's pinocchio. I mean when
the startup is becoming, you know, its own standalone, real
company that can exist without regular injections of investment cash. Obviously,
(18:19):
the earlier the startup is on the journey, the lower
its valuation is going to be. And only if the
startup is able to hold together and continue to develop
and reach certain milestones like finding the right leadership team
that's a milestone, or forming strong allegiances in partnerships with
other companies that's another milestone. Hitting these milestones tells the
(18:42):
investor community, Oh, you have reached the next kind of
level in your growth, and thus your valuation has increased
because you are more stable and you're on a better
footing for reaching profitability or eventually going public. As we said,
profitability kind of doesn't matter, it's kind of crazy, but
profitability in the view of investors, as in they're getting
(19:05):
a return on their investment. So that can also include
things like if you're able to show that you have
a really strong path toward generating revenue and scaling up
the business, that is incredibly valuable, enormously valuable, and a
lot of startups fail to ever reach that because scaling
(19:25):
is hard. Now, the goal of the investor is pretty simple,
to get a return on their investment, preferably a nice, big,
fat return. The goal of the startup that depends. There
are a few potential outcomes for startups, and depending upon
what the founders want, some of them may be desirable
(19:46):
and some of them may not be. All of them,
assuming everything turns out well, means that they will be very,
very wealthy. We're going to talk about those potential outcomes
after we take another quick break. All right. Before the break,
(20:12):
I mentioned that there are a few different potential outcomes
that are hoped for among startups in general and unicorns
in particular, and they're pretty easy to understand. One, as
I've mentioned before, is for the company to ultimately go public,
to become a publicly traded company. Usually this is managed
(20:35):
by having an initial public offering or IPO. There's a
whole process involved in that, and obviously it's not just
for the tech sector. It's for any company that's going public.
But the goal here is to offer shares of the company,
shares of ownership up for sale on the stock market,
(20:57):
and this will end up creating a big in jecttion
of capital which the business can then use toward, you know,
increasing the size of the business, expanding business in various ways,
business e business stuff. So it's all about growth really.
It does, however, mean also that the leadership and the
(21:20):
investors are seeding some control of this business to the shareholders.
Like when you own a share in a company, you
also technically have a say in how that company is run. Now, obviously,
if you only have a share and there are millions
of shares out there, your voice is a tiny one
and it's only through big collections that you can really
(21:43):
make any kind of movement. But there are groups that
form together to do just that. And they're also like
activist investors who will invest very heavily in a company
so that they have you know, a significant ownership, maybe
not you know, enough to rank a whole percent even,
but significant enough for them to be a voice that
(22:06):
is impossible to ignore. And that means that you know,
you're not making all of your own decisions. Some of
those decisions are subject to the whim of the shareholders.
It gets a little more complicated than that, but you
get the basic idea, But there's no rule that says
a startup, even a unicorn, has to go public. It doesn't,
(22:28):
It could remain a private company. The issue with that, however,
is that private companies don't have a way to generate
this enormous influx of capital the way a publicly traded
company does with an IPO, So it is very difficult
to get the capital together to do things like expand
(22:50):
the business and to scale up, and it might mean
having to get more investments, which you know that can
end up being a law term challenge, or relying upon
the company's own profitability where you're pouring the profits back
into the company itself, or to grow the business. But
(23:12):
that can be much much much slower than holding an IPO.
Even in publicly traded companies, growth isn't always enough. It's
not enough for a company to grow from quarter to quarter.
The rate of growth becomes important. Shareholders want to see
a company grow faster this quarter than it grew last quarter,
(23:33):
So the rate of growth is important, not just that
the company grew, but how fast did it grow. It's
wild to me that it could be a case where
you might say, oh, this company didn't grow as much
as we hoped it would, and therefore we've lost confidence
in it. It's crazy to me that that's a thing,
because the company still grew, it just maybe didn't grow
(23:57):
as fast as you liked. So like sometimes you'll see
headlines about a company reporting a decline in growth but
still growing. It's just not growing as quickly as it
was previously, and yet that can be seen as this
terrible sign. And I think personally this focus on growth
has been incredibly unhealthy for companies in general and for
(24:21):
society as a whole. I just don't think it's the
right philosophy. It's very difficult to sustain, and it drives
a lot of bad decisions. I would say, but that's
again I'm getting off topic. I apologize so anyway that
even with public companies or private companies, growth is always
(24:44):
a concern, and it's harder to do when you're a
private company. Sometimes there is a third option. You don't
have to go public, and you don't have to stay private.
The third option is he finds yourself a sugar daddy.
By that, I mean you find a bigger company that
wants to acquire your startup. This is kind of it
almost became a joke that people were going out and
(25:07):
founding startups just in the hopes that a bigger company
would come along and spend a ridiculous amount of money
to acquire the startup. And you don't have to worry
about whether or not your business is profitable, like that
never even becomes a concern. All you have to do
is create an organization that seems desirable for some reason
(25:27):
and then sign on the deadline and accept the big
old checks. And you didn't have to do something as
complicated as running a business and making it successful. There's
a bit of there's a bit of truth to that,
but that's obviously an oversimplification and almost a parody of
what's actually happening. So what is going on here, Well,
(25:47):
maybe the bigger company is looking at the startup as
a potential rival further in the future, and so the
bigger company wants to buy the smaller company before the
smaller company a company becomes a competitor. You can look
at Meta slash Facebook. That company has done this a lot,
purchasing companies that either we're already starting to compete with
(26:11):
Facebook's attempt to dominate online attention, or we're rising up rapidly,
and then Meta swoops in purchases the company for some
ridiculously high cost and then may or may not end
up doing anything with it. Maybe the bigger company sees
that there are bits and pieces of the startup that
(26:32):
could be useful in the bigger company's own products, Like
it's not that the startup itself represents something that the
company wants, but rather the assets that the startup has.
Some of those look really valuable, and maybe you incorporate
those into your own stuff, and then maybe later on
you even discontinue that stuff. I'm looking at you, Google,
Google does this all the time. But it remains that
(26:54):
sometimes the startup team is really just hoping to drive
valuation up as quickly as possible and get some offers
from bigger companies that can lead to a huge opportunity
to cash out. This can go different ways, too, right Like,
there are stories about startup founders who turned down fairly
big offers to buy out their company because they say, oh,
(27:17):
now this is undervaluing what we're going to do. And
sure maybe right now, like as of right now, you
know your your fifty million dollar offer is more than
enough to cover all the assets that we currently own,
but it doesn't cover the potential, and we would rather
bank on our potential than cash out for fifty million.
(27:37):
There are plenty of stories like that, but again, unicorns
are rare, or at least they're supposed to be. Remember,
like in twenty thirteen, when Aileen Lee first coined the
term unicorn, her company estimated that there were fewer than
forty companies that would merit unicorn status from two thousand
(27:58):
and three. Within that decade, there were like thirty nine companies.
But according to say CB Insights, as of July twenty
twenty three, there were over twelve hundred unicorns in the world.
And then not only that, you had variations that were
(28:21):
even more kind of grandiose than unicorn. There's the deccacorn,
that's a startup that hits a ten billion dollar valuation,
or the Hectocorn, which is a hundred billion that's a
lot of money. If you're wondering what companies were hitting
(28:43):
more than one hundred billion in valuation, SpaceX would be one.
Byte Edance, the parent company of TikTok is another. But yeah,
there are lots of companies out there that are in
the unicorn decacorn status a lot more than there were
back in twenty thirteen, so it's not nearly as rare
(29:05):
as it used to be. I mean, it's still not like,
if you go out there and launch a startup today,
you've got a real good chance of having a unicorn
on your hands. It is not that common, right, It's
still pretty darn rare. It's just way less rare than
it was when Alienly coined the phrase back in twenty thirteen. Okay,
(29:25):
that's it. That's what a unicorn is in the world
of business, and the tech world in particular is known
for these, So that's why I thought I would cover it.
I hope you are all well, and I'll talk to
you again really soon. Tech Stuff is an iHeartRadio production.
(29:49):
For more podcasts from iHeartRadio, visit the iHeartRadio app, Apple Podcasts,
or wherever you listen to your favorite shows.
Welcome to Tech Stuff, a production from iHeartRadio. Hey thereon
Welcome to Tech Stuff. I'm your host, Jonathan Strickland. I'm
an executive producer with iHeartRadio and how the tech are
you so. A decade ago, an investor named Aileen Lee,
(00:25):
the founder of a venture capital firm called Cowboy Ventures, which,
like crap, that's a great name. She coined the term
unicorn to describe a startup that has reached the unbelievable
milestone of a billion dollar valuation, and since then, tech
(00:46):
boffins have used the term unicorn to single out startups
that stand out from among the crowd. Every startup founder
is hoping for a unicorn. In fact, every investor is
hoping that they get in on the ground floor of
supporting a unicorn. The end goal for most investors is
(01:07):
to sink a decent investment in a startup, see that
startup climb and valuation to astronomical heights, and then rake
in the wealth when that company inevitably goes public. That's
the dream scenario. You see this huge return on your investment.
In fact, there are venture capital firms that really count
on a few of the companies they pick reaching a
(01:31):
level of unicorn status because it pretty much carries the
entire company. It'll help carry and balance out all the
ones that didn't really reach those levels. What's interesting to
me is that there's no point in this journey toward
billion dollar valuation where a startup actually needs to make
(01:53):
a profit. Startups can reach a billion dollar valuation without
making a profit. They could potentially make it without even
having a plan to reach profitability, although that's less likely.
Typically they will be at a point where they're generating revenue,
but they're not making more than what they're spending, so
they're still operating at a loss. So as an example
(02:15):
of this, I'll give you a unicorn example. The former
Twitter now X originally reached a billion dollar valuation back
in two thousand and nine, but Twitter didn't turn an
annual profit until two thousand and eighteen. Nine years later,
it was worth a billion dollars but had not yet
(02:38):
made an annual profit. It did make a quarterly profit
a couple of times before twenty eighteen, but the first
time it made a profit at the end of a
year was twenty eighteen. Crazy, So profits are not really
a necessity when it comes to achieving unicorn status. It's
certainly not a necessity for making a boatload of money
(02:58):
off of a company. Now, that was not always the case, right.
Once upon a time, investors were much fewer and further between.
It was harder to get hold of investment capital. So
for a business to really survive, it had to make
a profit, or at the very least, it had to
break even. Otherwise there was no way to cover the
(03:19):
costs of operation, and you would you run yourself out
of business. It'd be too expensive to run the business
to stay in business, and any hope of becoming an
enormous success really hinged upon being profitable. But let's put
that aside for a little bit. Let's get back to
talking about unicorns. So in twenty thirteen, Aileenlye writes a
(03:41):
piece titled Welcome to the Unicorn Club. Learning from billion
dollar Startups, and Lee called these billion dollars startups unicorns
because of their rarity. They were so incredibly rare. According
to her company's research, out of the thousands of companies
that had been launched in the previous decade from two
(04:03):
thousand and three to twenty thirteen, only point zero seven
percent of them reached a billion dollar valuation. I want
to say it was like thirty nine companies at the time.
So that raises a question, what exactly is valuation? How
do analysts determine or really, if we want to be accurate,
(04:27):
how do they estimate the value of a startup, especially
a startup that may not have a product to sell. Now,
with publicly traded companies, one way to measure value is
through market capitalization. This is a pretty simple concept, really,
So publicly traded companies have shares. Right, you can purchase
(04:50):
a share in the company. Each share is worth a
certain amount, and that amount is determined by the market. Now,
going into all the different forces that play into the
the share value of a company would go well beyond
my meager ability to explain. If I could explain all
of that in great detail, I would be in a
different tax bracket. But essentially, for market capitalization, you take
(05:16):
the number of shares that are outstanding the ones that exist,
in other words, and you multiply that number of shares
by the value per share. Then you get the market
capitalization of a company. So we'll use an overly simplified
hypothetical example. Let's say we've got a company and we're
calling it Willie's Widget Wonderland. It's a publicly traded company,
(05:38):
and the shares for Willy's Widget Wonderland are trading at
ten dollars per share. So for ten American dollars, you
can buy yourself a single share in this company. Let's
also say that there are only one hundred thousand shares
of this company at all, that's all that exists. Well,
we would then multiply these two numbers together, right, ten
(05:59):
dollars per share, one hundred thousand shares. That gives us
a million dollars. Boom, that's the market cap for Willie's
Widget Wonderland. Now, like valuation, market cap doesn't rely on
stuff like profit or revenue, at least not directly. Those
factors can play into the value of the company by
(06:21):
affecting the company's stock value, and that in turn does
affect market capitalization. So market cap tells us what the market,
the stock market in this case, values a company at.
Often investors will reference marketcap as the size of the company. Now, technically,
market cap doesn't indicate if a company is, you know,
(06:43):
physically larger or smaller than any other company, but rather
the size of its value in the marketplace. However, typically
larger cap companies are more established, and usually that means
they are also more stable than companies that have a
smaller market cap. But you know, to talk about the
(07:06):
value of a company beyond just the measure of market cap,
you have to talk about all sorts of other stuff,
like you might have to take into account how much
revenue the business generates, what are its costs of operation,
how much does it pay in taxes? You know, how
much of the business has depreciated over time, and by
how much. This kind of gets us into the dreaded
(07:28):
EBITDA or EBITA as I've heard it said that actually
it's eb I t DA. It stands for earnings before interest, taxes,
depreciation and amortization, And y'all, I have been in meetings
where EBEDA is part of the discussion, and every time
it happens, I can feel my eyes start to glaze over.
(07:52):
I will say that there are critics who have argued
that EBEDA has been misused, that companies have leaned on
EBEDA to perhaps overstate their profitability because it does take
a lot of costs out of that equation, and that
it's really just a way for companies to make it
seem like they're doing a lot better than perhaps how
(08:13):
they are really doing once you take all of these
different factors into consideration. But to get into it further
would mean we'd need to find another host because I
would fall asleep. And anyway, we're not really talking about
publicly traded companies, are we We're talking startups. So a
startup typically is a privately held company, a corporation. It
(08:33):
usually has the goal of becoming a publicly traded company
at some point in the future. It's not necessarily its goal,
but often that is the understanding among both the startup
itself and its investors. So how the heck do you
assign value to an entity like that. It's not a
(08:54):
business that's established, that has a history, that has actual
spreadsheet showing things like costs versus revenue. How do you
put a value on a startup that, perhaps in its
earliest stage, is very little more than just a good idea,
or hopefully a good idea. And that's a really good question.
(09:15):
So let's imagine that we have a brand new startup
and the founders have, you know, an interesting idea, but
at the start, they don't actually have a product to sell.
There's no operating income for the business. Maybe they've got
a company structure, like maybe they've designated officers for the
business who are in charge of specific functions, but as
(09:36):
of right now, they're not yet producing something that they
can sell. How do you place a value on that
kind of operation? But hold on, it gets even more
complicated than that. Let's say that this startup is a
really new idea, like it's really innovative, something that hasn't
seen much or perhaps any representation in the market as
(09:59):
of right now. Now, well, that makes it even harder
because it means you have very little you can compare
that startup against in the market, So that becomes a
barrier to valuation. You can't say, oh, well, this other
company is valued at such and such, so that's probably
the ballpark where we need to look at for this
other startup. If the two startups are nothing alike, then
(10:19):
there's no reason to port over that value from company
A to company B. On top of that, the market
changes quickly, which makes it really hard to predict how
the startup is going to perform in the future. So
will the market continue to support this startups business model
and thus lead to enormous growth, which is what all
(10:41):
the parties involved want to see. Or will the market
itself change and thus the business model then becomes irrelevant.
It's not that the business model was bad, it's just
it no longer applies because the market itself has changed.
Or will it turn out that the market demand for
the company's product just isn't there, like you think it's
(11:01):
there because it sounds like a great idea, but once
you actually get it out there, no one really seems
jazzed about it. Here this reminds me kind of of
how I see the metaverse right now. Obviously, the metaverse
itself is not a startup, but the fact that I
often see a lack of enthusiasm in the general public
around the concept of the metaverse makes me question the
(11:22):
wisdom of investing billions of dollars into that idea. So
the truth of the matter is that lots of factors,
some of them subjective ones, will come into play to
determine a startup's value, and they can include things like
investor opinions. If investors are enthusiastic about a startup, that
startups valuation typically goes up. But other stuff involves things
(11:46):
like market trends or assumptions about the market in general.
So it gets very whibly wobbly. We're going to take
a quick break. When we come back, I'm going to
talk about some approaches toward assigning value to startups. Okay,
(12:08):
we're back. So, as I mentioned, there are a couple
of different ways that investors will attempt to assign value
to a startup, which will ultimately determine whether a startup
reaches Unicorn status. One of those ways is called the
market multiple approach. So broadly speaking, this method takes a
look at recent acquisitions in whatever sector the startup is in.
(12:33):
So if the startup is at all similar to other
businesses that are part of these acquisitions, this is a
good approach, or at least a viable one. So what
you do is you look at the acquisitions that have
been made. You also take a look at how much
those businesses, those startups that got acquired, how much were
they making in sales or how much sales were they
(12:53):
actually seeing at the time of acquisition, And then how
much of a multiplayer is there for the amount of
sales versus the amount that was paid for at acquisition.
That gives you your market multiple. So let's talk about
our fictional widget company again. Let's imagine the widget company
is not publicly traded, it's a startup. And let's say
(13:16):
that investors look at how much other companies are paying
to acquire hardware companies that are in some way similar
to this widget company, and it turns out the acquisition
price is about six times greater than the actual sales
that these companies are making. That that's the average that
you're seeing across these acquisitions six times more. So your
(13:36):
market multiple is six and you can use that multiple
to kind of estimate your own company's valuation, though obviously
you're going to have to tweak that depending upon the
status of your own startup. So for example, if you
haven't really built out manufacturing facilities yet and you don't
actually have anything to sell, well, you can't really multiply anything.
(13:57):
If you're at very low scale then and maybe your
multiple is much lower because you haven't proven that you
can scale the business up yet, and that means that
investors are taking on a greater amount of risk when
they invest in your company. So your multiple ends up
being smaller than the market six times multiple that you're
(14:18):
seeing elsewhere. But this can be a way to kind
of guide you toward valuation. Obviously, the big hurdle here
is that the market multiple approach is dependent upon finding
comparable businesses in the market that have been acquired. If
your startup is really innovative and really doesn't resemble other
(14:38):
stuff that's already on the market, then you don't have
anything to compare it against. You don't have any way
to derive the multiple in the first place, because there's
no one else out there that's like you. So you
can't depend upon what's happening in other parts of the
market because it may not have any application toward your situation. However,
there are other means to assign valuation. So another is
(15:00):
called the cost to duplicate. This is pretty self explanatory.
How much money would it take to build a duplicate
copy of the startup in question. Now, actually coming up
with that figure can be a little tricky because it
can involve stuff that's a little more ephemeral than just
how much do the facilities cost? How much is the
(15:21):
business paying its staff, like how much is not just
rent but the cost of operations. It can actually include
other stuff too, like intellectual property that becomes harder to
put an actual, like monetary value to and that gets
a bit wishy washy, or things like the value of
(15:43):
research and development that's going on within the startup. How
do you put a monetary value on that. So the
cost to duplicate has a pretty big drawback. It gives
a snapshot of a company's current value, but it doesn't
necessarily take all of its assets into account because not
all of them are so easily reduced to a figure,
(16:04):
and it cannot bring into account the potential for the
company's success. Right It's looking at a snapshot of why
it's valued right now, but it's not telling you what
will it be valued six months from now, assuming that
everything's working well. So there are assets that just might
not be quantifiable, but they are still valuable to the organization,
(16:26):
but they're not going to show up on a spreadsheet
because he can't reduce it down to that data point.
For that reason, the cost to duplicate method can undervalue
a startup, sometimes by a significant amount. So you could say, like,
all right, well this is the low ball range of
the company's valuation. That would be a safer thing to say,
because you are acknowledging that this cost to duplicate method
(16:50):
does not take all assets into account because it just
it's not designed to be able to do that. Next up,
we've got the discounted cash flow method, or DCF method,
and in some ways it's kind of the opposite of
the cost to duplicate approach, because it's all about looking
forward as opposed to getting a snapshot of current value.
(17:13):
The DCF method requires analysts to predict how much cash
flow a startup will have in the future, and then
also bring into account the expected return on investment that
the startup is going to create, and putting those together
tells you how much that cash flow itself is worth,
and that ends up allowing you to place a valuation
on the company. To me this method comes across a
(17:36):
lot like telling fortunes. You're making the best guess you
can based upon the information that's currently available, but knowing
how things can change quickly means that at some level
you really have to acknowledge that this approach is far
from bulletproof. The last method can sometimes feel the most
arbitrary of them all. It's called the valuation by stage method,
(17:58):
So this method assigns value based upon how far along
the startup is as it develops to become a real boy. Wait,
I'm sorry, No, I'm sorry, that's pinocchio. I mean when
the startup is becoming, you know, its own standalone, real
company that can exist without regular injections of investment cash. Obviously,
(18:19):
the earlier the startup is on the journey, the lower
its valuation is going to be. And only if the
startup is able to hold together and continue to develop
and reach certain milestones like finding the right leadership team
that's a milestone, or forming strong allegiances in partnerships with
other companies that's another milestone. Hitting these milestones tells the
(18:42):
investor community, Oh, you have reached the next kind of
level in your growth, and thus your valuation has increased
because you are more stable and you're on a better
footing for reaching profitability or eventually going public. As we said,
profitability kind of doesn't matter, it's kind of crazy, but
profitability in the view of investors, as in they're getting
(19:05):
a return on their investment. So that can also include
things like if you're able to show that you have
a really strong path toward generating revenue and scaling up
the business, that is incredibly valuable, enormously valuable, and a
lot of startups fail to ever reach that because scaling
(19:25):
is hard. Now, the goal of the investor is pretty simple,
to get a return on their investment, preferably a nice, big,
fat return. The goal of the startup that depends. There
are a few potential outcomes for startups, and depending upon
what the founders want, some of them may be desirable
(19:46):
and some of them may not be. All of them,
assuming everything turns out well, means that they will be very,
very wealthy. We're going to talk about those potential outcomes
after we take another quick break. All right. Before the break,
(20:12):
I mentioned that there are a few different potential outcomes
that are hoped for among startups in general and unicorns
in particular, and they're pretty easy to understand. One, as
I've mentioned before, is for the company to ultimately go public,
to become a publicly traded company. Usually this is managed
(20:35):
by having an initial public offering or IPO. There's a
whole process involved in that, and obviously it's not just
for the tech sector. It's for any company that's going public.
But the goal here is to offer shares of the company,
shares of ownership up for sale on the stock market,
(20:57):
and this will end up creating a big in jecttion
of capital which the business can then use toward, you know,
increasing the size of the business, expanding business in various ways,
business e business stuff. So it's all about growth really.
It does, however, mean also that the leadership and the
(21:20):
investors are seeding some control of this business to the shareholders.
Like when you own a share in a company, you
also technically have a say in how that company is run. Now, obviously,
if you only have a share and there are millions
of shares out there, your voice is a tiny one
and it's only through big collections that you can really
(21:43):
make any kind of movement. But there are groups that
form together to do just that. And they're also like
activist investors who will invest very heavily in a company
so that they have you know, a significant ownership, maybe
not you know, enough to rank a whole percent even,
but significant enough for them to be a voice that
(22:06):
is impossible to ignore. And that means that you know,
you're not making all of your own decisions. Some of
those decisions are subject to the whim of the shareholders.
It gets a little more complicated than that, but you
get the basic idea, But there's no rule that says
a startup, even a unicorn, has to go public. It doesn't,
(22:28):
It could remain a private company. The issue with that, however,
is that private companies don't have a way to generate
this enormous influx of capital the way a publicly traded
company does with an IPO, So it is very difficult
to get the capital together to do things like expand
(22:50):
the business and to scale up, and it might mean
having to get more investments, which you know that can
end up being a law term challenge, or relying upon
the company's own profitability where you're pouring the profits back
into the company itself, or to grow the business. But
(23:12):
that can be much much much slower than holding an IPO.
Even in publicly traded companies, growth isn't always enough. It's
not enough for a company to grow from quarter to quarter.
The rate of growth becomes important. Shareholders want to see
a company grow faster this quarter than it grew last quarter,
(23:33):
So the rate of growth is important, not just that
the company grew, but how fast did it grow. It's
wild to me that it could be a case where
you might say, oh, this company didn't grow as much
as we hoped it would, and therefore we've lost confidence
in it. It's crazy to me that that's a thing,
because the company still grew, it just maybe didn't grow
(23:57):
as fast as you liked. So like sometimes you'll see
headlines about a company reporting a decline in growth but
still growing. It's just not growing as quickly as it
was previously, and yet that can be seen as this
terrible sign. And I think personally this focus on growth
has been incredibly unhealthy for companies in general and for
(24:21):
society as a whole. I just don't think it's the
right philosophy. It's very difficult to sustain, and it drives
a lot of bad decisions. I would say, but that's
again I'm getting off topic. I apologize so anyway that
even with public companies or private companies, growth is always
(24:44):
a concern, and it's harder to do when you're a
private company. Sometimes there is a third option. You don't
have to go public, and you don't have to stay private.
The third option is he finds yourself a sugar daddy.
By that, I mean you find a bigger company that
wants to acquire your startup. This is kind of it
almost became a joke that people were going out and
(25:07):
founding startups just in the hopes that a bigger company
would come along and spend a ridiculous amount of money
to acquire the startup. And you don't have to worry
about whether or not your business is profitable, like that
never even becomes a concern. All you have to do
is create an organization that seems desirable for some reason
(25:27):
and then sign on the deadline and accept the big
old checks. And you didn't have to do something as
complicated as running a business and making it successful. There's
a bit of there's a bit of truth to that,
but that's obviously an oversimplification and almost a parody of
what's actually happening. So what is going on here, Well,
(25:47):
maybe the bigger company is looking at the startup as
a potential rival further in the future, and so the
bigger company wants to buy the smaller company before the
smaller company a company becomes a competitor. You can look
at Meta slash Facebook. That company has done this a lot,
purchasing companies that either we're already starting to compete with
(26:11):
Facebook's attempt to dominate online attention, or we're rising up rapidly,
and then Meta swoops in purchases the company for some
ridiculously high cost and then may or may not end
up doing anything with it. Maybe the bigger company sees
that there are bits and pieces of the startup that
(26:32):
could be useful in the bigger company's own products, Like
it's not that the startup itself represents something that the
company wants, but rather the assets that the startup has.
Some of those look really valuable, and maybe you incorporate
those into your own stuff, and then maybe later on
you even discontinue that stuff. I'm looking at you, Google,
Google does this all the time. But it remains that
(26:54):
sometimes the startup team is really just hoping to drive
valuation up as quickly as possible and get some offers
from bigger companies that can lead to a huge opportunity
to cash out. This can go different ways, too, right Like,
there are stories about startup founders who turned down fairly
big offers to buy out their company because they say, oh,
(27:17):
now this is undervaluing what we're going to do. And
sure maybe right now, like as of right now, you
know your your fifty million dollar offer is more than
enough to cover all the assets that we currently own,
but it doesn't cover the potential, and we would rather
bank on our potential than cash out for fifty million.
(27:37):
There are plenty of stories like that, but again, unicorns
are rare, or at least they're supposed to be. Remember,
like in twenty thirteen, when Aileen Lee first coined the
term unicorn, her company estimated that there were fewer than
forty companies that would merit unicorn status from two thousand
(27:58):
and three. Within that decade, there were like thirty nine companies.
But according to say CB Insights, as of July twenty
twenty three, there were over twelve hundred unicorns in the world.
And then not only that, you had variations that were
(28:21):
even more kind of grandiose than unicorn. There's the deccacorn,
that's a startup that hits a ten billion dollar valuation,
or the Hectocorn, which is a hundred billion that's a
lot of money. If you're wondering what companies were hitting
(28:43):
more than one hundred billion in valuation, SpaceX would be one.
Byte Edance, the parent company of TikTok is another. But yeah,
there are lots of companies out there that are in
the unicorn decacorn status a lot more than there were
back in twenty thirteen, so it's not nearly as rare
(29:05):
as it used to be. I mean, it's still not like,
if you go out there and launch a startup today,
you've got a real good chance of having a unicorn
on your hands. It is not that common, right, It's
still pretty darn rare. It's just way less rare than
it was when Alienly coined the phrase back in twenty thirteen. Okay,
(29:25):
that's it. That's what a unicorn is in the world
of business, and the tech world in particular is known
for these, So that's why I thought I would cover it.
I hope you are all well, and I'll talk to
you again really soon. Tech Stuff is an iHeartRadio production.
(29:49):
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