Are Unicorn Valuations Bloated?
With the increased scrutiny on valuations for late-stage private tech companies (see unicorn), I wanted to quantify the level of overvaluation. Should they really be worth 2/3, 1/2, or even 1/4 of their current valuation? This is obviously a nuanced discussion, valuations have many inputs, and these companies are clearly kicking ass in their respective industries. However, the biggest driver of high valuations is revenue growth, which we can see from the chart below:
Most public tech companies aren’t growing anywhere near as fast as unicorns though, so just comparing valuation multiples doesn’t capture the entire picture. To make a better comparison, I created a new metric — a Growth / Multiple ratio. You take your Revenue Growth Rate, and divide it by your Valuation Revenue Multiple, similar to a P/E/G ratio. For example, if I’m a hot company growing at 100% yoy, and my latest round valued me at 10x revenues, my ratio would be 100/10 = 10x. Below is the distribution of those ratios for high growth public companies, the median is around 8x. That means that if a company is growing 100% yoy, they should be valued at 12.5x trailing revenues, and 200% gives you 25x trailing revenues.
Note that a lower Growth/Multiple ratio means you are overvalued, and a higher ratio means you are undervalued.
This allows us to understand if we’re overpaying for growth. Lets look at some unicorn revenue multiples now and understand where we’re sitting (thanks to CB Insights).
From above, we see that some of these companies are actually “undervalued” based on their reported growth. Others are 2–4x overvalued. As you go down the list, most companies with high revenue multiples (>15x) will have a lower Growth/Multiple ratio than 8x (meaning they are overvalued). Given that they are illiquid companies, there should be a discount from the public markets, so they are definitely valued too highly. The numbers above are based on publicly available information, so I’d love if people were able to verify/negate these numbers further.
So what’s the takeaway? Many of these high-growth startups have bloated valuations, and their value should probably be closer to 1/2 what they are currently. Is that a massive bubble? No. However, will the public markets value these companies as highly as the private markets do? No.
The main downside I see will be that maintaining these growth rates at ever-larger sizes is going to burn tons of cash, and nobody wants to raise more money at the same or lower valuation (see down-round). Investors should be careful of continually feeding the bloated unicorn, because at some point it needs to lose some weight for the public markets.
Note for my finance geeks: Companies are generally priced based on a forward revenue multiple, but we only have trailing multiples for the unicorns. That’s why I used a LTM Growth/LTM Revenue ratio for the public companies — if we use both LTM we can still make a comparison to the unicorn.