When we talk about unicorns, there’s a lot of focus on valuation. But where does that number come from, anyway?
First, it’s important to understand that much like the unicorn itself, valuation is often a fairy tale. It’s an estimate at best, derived from the potential for growth and development that’s expected. It’s about long-term forecasting — not the current position of the business. In fact, not one pound in profit is necessary for establishing a valuation, and therefore, it’s not at all related to actual performance.
In many cases, a unicorn is not comparable to any other business. It’s the first of its kind, so it’s hard to argue with its assigned valuation.
It’s in the best interest of the unicorn to have the highest valuation possible. But why?
In order for the unicorn to survive the short term, it’s got to receive large rounds of funding. And if a high-stakes investor is going to hand over millions, the valuation has to be astronomical. Only then can large amounts of market share be captured, to prevent the appearance of competitors. In short, get as big as possible, as quickly as possible, so anyone else would be crazy to think they could compete.
Another reason that high valuations are attractive is acquisition. High valuations bring high premiums, and when start-ups receive extraordinary buy-out offers, they can use those to further validate their existence.
And since those high valuations bring in premium investments, innovations can move more quickly, customers can be reached in record time, and mass production can be achieved.
So, in truth, valuation is not about real money. It’s about what business owners and current investors want new investors to believe the start-up is worth.
The metrics that were once used to determine value, like multiples of profit and revenue, comparability in the industry, discounted cash flow, cost of replacement…are not used to designate a start-up as a unicorn.
The only way to determine true valuation is through an IPO (Initial Public Offering). Those interested in viability, sustainability and relevance will want the real numbers. They’ll say, ‘Show me the money.’
And unicorns will struggle to do that. That means they’re still…you’ve guessed it…mythical creatures.