The Age of Unicorns (opens in new tab)

About this:

"When Cowboy Ventures founder Aileen Lee coined the term unicorn as a label for such corporate creatures in a November 2013 TechCrunch blog post, just 39 of the past decade’s VC-backed U.S. software startups had topped the $1 billion valuation mark. Now, casting a wider net, Fortune counts more than 80 startups that have been valued at $1 billion or more by venture capitalists."

Again, this is because interests rate, in general, are very low, much lower now than they were during the original Dot Com boom, which is why valuations are higher. The math on this is simple.

Suppose you have a company that makes $1 million in profits. The question then is, at what point does it make sense to invest in something else? When prevailing interest rates are 10%, then $1 million is 10% of $10,000,000, so the company is worth $10,000,000 (excluding a million other factors for the sake of a simple model). If the company demands more than $10,000,000 to buy it, then it makes sense to invest in something else instead. If a company wants less than $10,000,000 for ownership, then it is a hot deal.

But when prevailing interest rates drop to 1%, as now, and since $1 million is 1% of $100,000,000, then for same level of profit, the value of the company has gone from $10,000,000 to to $100,000,000.

Again, there are a million other factors you could consider (do you trust the management, can they scale, how fast are they growing) but I'm going with a simple model here to demonstrate the basic driving force of modern valuations: when interest rates go down, valuations go up.

Of course, that doesn't explain why a web startup with no profits would be valued more than, say, a mature company like GE, which has known profits. Some of the wilder valuations are obviously being driven by speculation about wild growth rates.

Taken by themselves, it is hard to say which one is overvalued. But looking at the entire class, I think they are definitely overvalued. The trick will be to figure out which one of these companies is the Amazon among the Webvans....

I feel a terrible unease about these companies. It's not the bloated valuations, but rather the motivation for running companies in this way. The plc has many critics, as a model of risk sharing and financial transparency it's got huge holes right through it as Enron (and other car crashes) showed. But who has a clue about what's happening in these companies, and who, and what (banks, pension companies, taxpayers, plc's) are being taken for a ride?

Caution...

Consider Facebook's valuation and then consider how they actually make money. Do they even make money outside of advertising, and is that advertising over valued? How many advertisers have already pulled out of Facebook ads due to ineffectiveness?

A lot of these companies are valued solely on the number of users, and little to due with anything else. Maybe someday they will spin it and turn all those users into profit, that seems to be the dream. It's not always a viable reality.

There's quite a few more billion+ venture backed start-ups not on the unicorn list.