January 7 2015
by Todd Hixon

Unicorn Hunting Is Not The Only Way To Make Money In Venture Capital

[This post first appeared at on December 18, 2014.]

The U.S. venture industry has been fascinated by “Unicorns” (companies with a $1 billion exit or private valuation) in recent years. The term Unicorn, coined by Aileen Lee of Cowboy Ventures in a TechCrunch post three years ago, suggests a rare and magical thing. The current meme in the venture business holds that all the money is made by investors and entrepreneurs who find Unicorns.

Recently two of my colleagues published analysis (also in TechCrunch) that focuses on the question: how well did these Unicorn companies do for investors, specifically, how many of them returned 100% or more of the fund that made the investment?  They call companies that return 100% or more of a fund “Dragons”, in keeping with the mythical beast convention.

Surprisingly, only 27% of the investments made by VCs in Unicorns paid back a fund, despite the high exit values. Why? Because many of the investors in these companies are big funds that came in at later stages and high valuations, paying a big price for a small share. Hence, they got a piece of the glory, but they did not earn a high multiple on capital for investors.

Clearly the Unicorns are great outcomes for the entrepreneurs, and many of them turn into important companies. That is a very good thing. But it leaves venture capital investors with an important question: where do I find Dragons?

Data from Silicon Valley Bank.

Analysis by Silicon Valley Bank based on the Prequin database.

Could it be that sub-billion dollar exits actually produce a lot of Dragons and other “fund-makers”: exits that return a large part of a fund? It’s hard to count them, because the smaller exits are numerous and often details are not disclosed. But the math says this can easily work: if a $100 million fund owns 20% of a company that exits for $500 million, it will receive $100 million of proceeds, and that’s a Dragon. And $500 million exits are much easier to find than Unicorns.

The chart above sheds light on this by analyzing results at the fund level. It shows that smaller funds have returned higher multiples of invested capital than large funds. Most of the return in venture funds comes from a handful of very successful investments: Dragons and fund-makers. It follows that the small funds are finding more Dragons and fund-makers than the big funds, and these exits are driving the higher overall cash-on-cash multiple they achieve. This is the classic thesis of early stage venture investing: come in early, buy a substantial stake, and ride the appreciation in the winners to a high exit multiple.

So, why the fascination with Unicorns? They are very visible and glamorous, and they make good copy, as the media attention shows. They appeal to the gambling instinct that is part of human nature: many people prefer a small chance of a very big win (a lottery ticket) to a bigger chance of a smaller win. They are great achievements for their entrepreneurs. But, to a surprising extent, Unicorns don’t drive outsize returns for the funds that made the investment.

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