Skimming through data on the number of unicorns emerging this year has thrown up some interesting trends.
CB Insights found only new VC-backed unicorns had emerged in 1Q16. Compared to the peak of the unicorn frenzy in 2Q15 and 3Q15, when 24 and 25 new $1 billion+ companies were created, respectively, unicorn creation is back to 2013 levels.
This trend follows a long series of announcements about markets and investors starting to take things seriously, that this year is going to be tougher for startups, and that rationality and valuations based on positive cash flow generated rather than discounted future value will drive investment decisions this year.
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These are peculiar things to observe, because no less than six months ago, venture capitalists and growth equity funds were displaying aggressive interest in financing later, pre-IPO stages. So where are the unicorns then?
And what keeps the IPOs at bay? There is general consensus now that one should exercise caution with unicorns, as they always resemble a market that can be potentially skewed. Today’s most successful investors are praised on their state of patience and that’s a rather worrying indicator to assess their capabilities. I wouldn’t play all the cards on patience, which removes the pressure of an exit, even when it comes to companies like Airbnb and Uber, which seem to be disrupted, themselves, by the advent of blockchain technology. But no one really seems to talk about it.
Talking about IPOs and the rate of success of VCs judging by the returns they generate, look at the chart below presenting the returns of the MSCI World, a stock market index aggregated from 23 developed economies.
The annualised return is surprisingly smooth for over nearly four decades, hovering around 10 percent, and only turns negative at the peak of the financial recession in 2008 and 2009.
In other words, the rate of return of investing in venture capital barely surpasses the return of investment from the public markets. This reveals that investors are probably not as good at estimating opportunities, that they still go through consistent episodes of FOMO (Fear Of Missing Out) versus FOLD (Fear Of Losing Dollars) hype cycle. There are probably tons of good companies out there that deserve a chance from good investors not speculators, who are capable of recognising true innovation.
There were exceptions, of course. Through 2000, the returns to venture capital firms, while highly skewed by a small number of persistent out-performers, had substantially exceeded the NASDAQ index.
However, since 2000, the VC returns have actually under performed NASDAQ. That is in significant part due to the substantial closing of access to an active speculative market for initial public offerings. There have been some highly visible major IPOs, and a modest recovery in the number of IPOs in the last few quarters. But in general, since 2001, the IPO market has been running at a rate below where it ran for almost 20 years, from 1982 to 2001.
Something interesting to note is how similar the investor’s emotional hype cycle is with that of a startup's.
What can we learn from all of this? Well as a start, it seems that investment in venture funds and private equity resembles the standard pattern of investment in public and speculative markets, which is rather disappointing when you recall that we, the VCs, operate in young, innovation-fuelled, yet-to-mature industries. In the words of Warren Buffet, we behave like another mediocre or speculative investor would behave hence creating mediocre returns instead of tuning out and placing bets on true winners.
Are we still able to find true winners and validate them?
I would like to believe so.
The low amount of unicorns being created this year is surely a positive signal to me. That would mean that the capital is getting back to the initial earlier stages of funding startups rather than in later stages, postponing their validation on the public markets, on the premise that patience is virtue in potentially gigantic markets.
There are yet true winners waiting to be discovered. Call me old fashioned, but I, as a VC, would rather find them and invest in them putting all our efforts to generating net positive cash return, rather than making mythical animals out of them.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)
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