Don’t be fooled by unicorn valuations

The so-called unicorns, the fast-growing breed of 21st-century startups worth more than a billion dollars, have been so celebrated that it almost seems beside the point to ask, “Are they worth anywhere near their valuations?”

Fledgling student-loan provider SoFi recently raised $1 billion in equity at a valuation of more than $3 billion. Facebook paid $19 billion for privately held WhatsApp, a communications tool, before it had meaningful revenue. Uber, which has yet to report a profit, is worth $51 billion, per its latest private-market funding round. Disruptive or not, is there something that their backers are seeing that those in the rational investing world — they who assess companies on the present value of their future earnings — aren’t?

It honestly doesn’t matter. Private-market valuations are just that, the assessment of a small number of investors operating outside public scrutiny. Public-company valuations are tested every day that markets are open. The valuations of private companies shift only when they raise more money. In fact, says venture capitalist Keith Rabois of Khosla Ventures, “private-market valuations are more of an art than a science. They are a negotiation, with the venture capitalist asking, ‘At what price will somebody who doesn’t need my money take my money?’ ”

Several factors account for the abundance of venture-backed companies that have remained private well past the time they historically would have gone public. Low interest rates have made capital cheap and have encouraged institutional investors to seek superior returns in riskier bets. In turn, with so much available cash, private companies have been in no hurry to seek the glare of public markets. As a result, they are able to raise ever greater amounts at ever higher valuations.

Sometimes the eye-popping valuations aren’t exactly what they appear to be. For example, in an effort to achieve billion-dollar status — resulting in positive publicity, bragging rights for recruiting talent, and ego stroking for entrepreneurs — some companies accept onerous restrictions in return for higher paper values. Payments-software provider Square, for example, raised money at a valuation of $6 billion while promising investors that an IPO price below an agreed-upon level would trigger the issuance of additional shares. This would dilute other shareholders — and possibly hurt the valuation of the company.

All this behind-the-scenes maneuvering eventually ends, of course, when companies finally go public. Already, tech companies like Box and Hortonworks have been unable to hold public values that exceed their previous private valuations. A unicorn, after all, is a mythic animal whose true value is in never being seen. Public companies have nowhere to hide. The new cohort may continue to innovate, but eventually they, too, will be worth only what money they can make for their shareholders over time.

This first appeared on Fortune.com and also runs in the current issue of Fortune Magazine. Adam Lashinsky’s essays appear daily in Fortune’s Data Sheet newsletter. Subscribe to it here.