Why are unicorns worth what they are worth?

By Luis Bermejo, founder and Managing Partner of Alaya Capital.

The entrepreneurial world is at its peak, in the news we not only hear good ideas or entrepreneurial stories but also the results and returns of a startup’s road to success are on the agenda. Today all the media are talking about the new unicorns, their capital rounds and the extraordinary valuations of these companies. Undoubtedly, we are seeing the result of the efforts made in more than a decade to boost the entrepreneurial ecosystem.

This new wave of “unicorn” startups supports the basic concept with which venture capital funds work: startups are real agents of economic and social change. These companies grow fast, solve global problems and create new sources of employment. But the million-dollar question: why are unicorns worth so much?

The insurtech Betterfly raised $125 million dollars (mdd) in a Series C, with which it raised funds for $202.5 mdd and achieved a valuation of $1,000 mdd, thus becoming the first B company (social company) to be a unicorn in Latin America. But this valuation was not achieved in one day; startups increase their valuation as they grow and raise new rounds of private capital.

In this way, (according to Startupeable) a startup begins with an average valuation of up to 2 million dollars in its “pre-seed” round, advancing between 3 and 5 million dollars in its “seed” rounds and reaching up to 10 million dollars in its “post-seed” series. After passing this stage, startups go from being worth up to $30 million in their “Series A” and up to $60 million in their “Series B”. Once they pass their “Series C”, their valuation may already exceed 100 million dollars, on the way to becoming the famous “unicorns” when they exceed 1 billion dollars.  There it can continue to raise capital until it goes public.

These valuations are determined by venture capital funds based on expected growth, hoping that when they go public the market will validate or increase this valuation. From a traditional market perspective, these valuations may seem irrational and based on assumptions, not actual data.

Although they are focused on expectations, it is not unreasonable. While startups do not have similar levels of sales, profitability and trajectories to traditional corporations, they do have something that is their greatest asset: speed of growth. These types of startups are global technology-based solutions that have the ability to scale markets and take them over with exponential speed. Especially after the start of the pandemic in 2020 where the acceleration of digital transformation only increased the value of startups in this new normal.

The growth expectation is adjusted for market comparables of companies in the same industry that have achieved similar valuations and have been validated by the market once they have gone public. Ultimately, the valuation is confirmed at the end of the capital raising process and private equity funds value the companies with the expectation of that final value.

If we look at the top five companies in the U.S. stock market in 2001, there was only one technology company (Microsoft) and the others represented the traditional world: oil companies, banks and retail. By 2010, Apple was added to the top five with two technology companies. In 2021, this type of companies have taken over the podium of companies with the highest valuation in the U.S. stock market, with the addition of Amazon, Alphabet and Facebook.

Looking at Latin America, one of the first Argentine unicorns, Mercado Libre, is on the podium and this trend is expected to continue. The rise of unicorns in the region has generated more confidence in local investors to explore the world of venture capital and has attracted international funds, which have already announced their first investments in Latin America.

With the availability of capital, entrepreneurial talent and a market eager for digital transformation, these types of companies are expected to be the new market leaders.

There is no turning back, technology is here to stay and the agile startup model seems to be the most efficient in a world where the only constant is change.