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For What It’s Worth: Unicorns? – November 2016

In the good old days, private companies were worth less than comparable public companies.  This was due to their smaller size, lack of diversification, lack of access to capital, dependence on key people, and illiquidity, among other things.

Enter the “unicorns,” private companies currently valued at $1 billion or more.  Many of these steeds are valued at stratospheric multiples of revenue, earnings, and cash flow (if they earn any).

What is driving these valuations?

  • Easy Federal Reserve monetary policy, which has made capital cheap and plentiful
  • An influx of foreign capital seeking safe haven in the United States
  • Investors’ desire for higher returns with low interest rates and high stock prices
  • Venture capital firms success in raising large new pools of funds
  • Easier exits: venture-backed firms are increasingly sold to other companies, rather than going public and incurring regulatory scrutiny and expense
  • Favorable tax treatment of carried interests (which is at political risk)
  • VC firms’ FOMO: Fear Of Missing Out on the next big thing
  • The rapid pace of technological innovation in many fields

In short, the demand for apparently hot private companies exceeds their supply.

Unfortunately, this situation is not sustainable.  None of the above drivers is permanent.  When investor expectations change, there will be a last roundup of the unicorns, so to speak, to the glue factory.

I have seen four investment fads end with stampedes:

  • Late 1960s: Conglomerates went out of fashion when investors realized that it is impossible for even great managers to successfully run diverse businesses
  • 1989: LBOs crashed when a management-led buyout of United Airlines (a cyclical and capital-intensive business totally unsuited for a buyout) collapsed
  • Early 2000s: The “dotcom bubble” ended when investors realized that many of these firms had no visible revenue sources
  • 2008: The housing boom ended when investors realized that the supply of homes was far in excess of demand (fueled by careless bank lending and regulatory oversight practices)

This fad will end the same way, because unicorns are not horses of a different color!

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Western Reserve Valuation Services is an affiliate of Western Reserve Partners LLC, a FINRA-member investment banking firm offering financial advisory services relating to mergers and acquisitions, capital raising and financial restructuring. For more information on Western Reserve Partners, please or call (216) 589-0900.

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