Unicorns — the mythical, majestic, rainbow-colored, horse-like, flying creatures — are featured in a wide range of fairy tales and childrens’ books. But what if I told you there were real unicorns?
The real-life rendition of these mythical creatures isn’t a living, breathing animal. In investing circles, unicorns are privately held companies that have done something incredibly rare: they’ve grown to a valuation of $1 billion or more before being publicly traded.
Seeing a startup valued at more than a billion bucks that’s about to go public is exciting for many investors, who often begin to pour into the stock, driven by the fear of missing out (FOMO). But is investing in a relatively new company with a tremendously high valuation really a good idea?
What Is a Unicorn Startup Company?
The term unicorn company is used in the venture capital industry to describe a privately held or startup company with a valuation of more than $1 billion. Seems simple enough right? So, why is it that unicorn companies are so hard to find?
Because it is incredibly rare for private companies to reach a valuation of more than $1 billion without the help of the public markets. For these companies to reach unicorn status, one of two things has to be true:
- A privately held company has generated such strong sales that a valuation of $1 billion or more is justified by this incredible performance.
- A startup company has an idea that’s so innovative that even the experts are willing to throw caution to the wind for a chance to get involved in what may become a revolutionary offering.
That doesn’t happen often.
Venture capitalist Aileen Lee, founder of Cowboy Ventures and the expert who coined the term, described four main categories of unicorn companies, which include consumer audience, e-commerce, software-as-a-service, and enterprise software. Her research showed that the vast majority of unicorn companies were split relatively evenly across these four key business models.
Examples of Unicorn Companies
Keep in mind that unicorn companies are startup companies that have grown to be worth more than $1 billion. That’s exceptionally rare, but it does happen. According to CBInsights, there are currently more than 900 companies in this category today, with a large number of unicorns in the U.S. and China, as well as several in India, Germany, South Korea, and the United Kingdom. Some unicorn companies that you may have heard of include:
- Airbnb. Founded in 2008, Airbnb quickly grew to become the online vacation rentals hotspot. The application gives homeowners a way to earn money from investment properties or their own homes when they’re traveling, and gives travelers a wide array of lower cost, higher value options for rentals during their vacations or work trips. The company launched its IPO in December 2020 at $146 per share, closing its opening day with a market cap of more than $86 billion.
- Epic Games. Epic Games is the creator of the smash hit video game Fortnite. The company has also seen success with its titles Infinity Blade and Unreal Tournament. Epic Games surpassed a $17 billion valuation long before any plans of an IPO.
- DoorDash. DoorDash is a food delivery service that adds a delivery component to restaurants that didn’t previously offer the service. The move proved to be a great idea, resulting in a startup company with a value of more than $13 billion that has reached as high as $16 billion.
- SpaceX. SpaceX is the super-unicorn on this list, valued at a whopping $100 billion as of early 2022. The company, founded by Elon Musk, was launched in 2002 with the goal of revolutionizing space technology. Since its inception, the company has been a wild success and a hot topic of television coverage and social media.
One similarity you’ll notice among all of these companies — other than the fact that they have tremendously high valuations — is the fact that they are all tech companies. Looking at the full list of unicorn companies on CBInsights, you’ll find that the top 10 unicorn companies by valuation are centered around innovative technology in one way or another.
Pro tip: If you’re thinking about adding a unicorn company to your portfolio after they go public, make sure you do your due diligence. Stock screeners like Trade Ideas can help you narrow down the choices to companies that meet your requirements. Learn more about our favorite stock screeners.
By definition, unicorn companies are private companies with valuations of at least $1 billion. However, the real question is, how fair are those billion-dollar valuations? After all, if you plan on investing in these companies, you want to make sure you’re getting a fair deal.
Unfortunately, a peer-reviewed study posted on ScienceDirect suggests that’s not generally the case. The authors of the study developed a fair valuation model for venture-backed unicorn companies, which they then applied to 135 unicorn companies. The study found the average company in the category was overvalued by a whopping 48%.
This suggests early investors who dive into unicorns before they go public are essentially overpaying for the opportunity to become an early investor.
Many unicorns encounter a harsh reality when they make it to market. Just take a look at Uber’s stock: in 2019, the company launched its IPO at $45 per share. Early investors hoped the stock price would go straight up once it went public, but instead it languished below $40 per share for most of the next year, and today trades about $10 below its IPO price.
Pros and Cons of Unicorn Companies
As with any investment, investing in a unicorn company comes with pros and cons.
Pros of Investing in Unicorns
There are several benefits to investing in unicorn companies. Some of the most impressive include:
- You Likely Know the Company. Unicorn companies don’t grow to billion-dollar valuations before their IPO without a reason. These companies have created something highly innovative. If the product they’ve created is on the market, it is likely a very popular one. If it hasn’t hit the market yet, a large audience likely already knows it’s coming. There’s a strategic benefit to investing in companies that you have heard of and know well. Remember, educated investing gives the investor a better chance of seeing growth.
- Some Unicorns Really Do Fly. As their namesake mythical creatures do, some unicorn companies fly following their IPO. A great example of a successful unicorn company is Zoom. The stock debuted in 2019 at just $36 per share. One year later, the stock was trading at well above $100 per share, briefly hitting a peak above $500 per share in late 2020. Today, even after significant consolidation, the company’s valuation sits at well over $40 billion and shares trade in the triple digits.
- Innovation Has Long-Term Value. Unicorn companies are the kings of innovation, and there’s tremendous value in that. Those that do hit tend to hit hard, generating tremendous long-term profits. Take a look at Tesla. After launching a unicorn IPO at $17 per share in 2010, the stock has never fallen below its IPO price. Just 11 years later, the stock is worth nearly $1,000 per share.
Cons of Investing in Unicorns
While there are plenty of clear benefits to investing in unicorn stocks, even the most beautiful rose will have thorns. There are a few drawbacks to consider when investing in these stocks.
- Billion-Dollar Valuations Don’t Necessarily Mean Profits. Although all unicorn companies have valuations at $1 billion or higher, many lack something important: profits. Consider Uber — the ridesharing company is valued at more than $65 billion. However, it has yet to turn a single penny in profits. In fact, the company loses millions of dollars every quarter. Many other unicorn companies follow along these lines, making them risky plays. After all, a company that operates on losses will eventually run out of money.
- Ridiculous Overvaluations. Unicorn companies are generally valued on different metrics compared to others in their sector. Therefore, when looking at fundamental valuation metrics like price-to-sales or price-to-book value, these companies generally come with ridiculous overvaluations. That means when you invest in a unicorn company, you are banking on the company being overwhelmingly successful and growing at a much faster rate than the average company within its sector. That can prove to be a risky bet to make.
- Lack of History. A unicorn company gets its billion-plus-dollar valuation from venture capitalists and institutions that fund it early on. However, these companies are pre-IPO, meaning that the market hasn’t had the opportunity to price the company. Oftentimes, the market doesn’t believe the company is as valuable as institutions do, leading to declines once a stock hits the public stock exchange. However, without any trading history, there’s no way to determine how the overall market will value the company.
Should You Invest in Unicorn Companies?
Unicorn companies are exciting for investors because of the significant gains they can create. However, any time there’s an opportunity for significant gains, there’s also the opportunity for significant losses.
Investments in unicorn companies are highly speculative. This means these investments are made under the speculation that an innovative technology will be a game-changer in a specific sector. Unfortunately, unless you’re a fortune teller, there’s no way to say that for certain.
Just like any other company, unicorn companies can do belly flops, and due to their overwhelmingly high early valuations, their belly flops have a tendency to be incredibly painful. So, it takes a special kind of investor to invest in these types of stocks.
In particular, if you’re an investor with a heavy risk appetite, a strong understanding of the implications of new and innovative technology, and the ability to take on losses and absorb them without losing your livelihood, unicorn stocks may be for you. On the other hand, if you’re not comfortable with risk and don’t have money to lose in the stock market, this is a category of stock you should stay away from.
How to Invest in Unicorn Companies
For the average investor, you’ll have to wait until a unicorn goes public; then, you’d be able to invest in it like any other stock.
However, while the unicorn is private, the average investor has no access. U.S. regulations limit private companies to only selling shares to accredited investors. This means in order to buy shares of a unicorn while it’s a private company, you must have a high net worth (over $1 million) or very high income ($200,000 per year for two consecutive years).
There is one workaround to this rule. Many private equity firms — firms that make money by investing in private companies as accredited investors — are also publicly traded. By investing in a publicly traded private equity firm, chances are you’ll gain exposure to a unicorn or two.
Frequently Asked Questions About Unicorn Companies
With unicorn companies being so rare, there are several questions people commonly ask about them. Some of the most common include:
Is Amazon.com a Unicorn?
Amazon.com is one of the largest companies in the world by market cap, but it’s not a unicorn and never was. That’s because the company is publicly traded, and was public for some time before its valuation crossed over $1 billion. In fact, you can trace the stock back to its early days on the market when its stock price sat at under $2 per share.
What Percentage of Startups Become Unicorns?
According to EMBroker, businesses only have about a 3 in 50,000 (0.00006%) chance of becoming a unicorn. While that’s rare, it’s still better than the odds of winning the PowerBall, which currently sit at 1 in 292.2 million.
Where Do Most Unicorns Live?
California — namely San Francisco and Silicon Valley — is the home to the largest concentrations of unicorns. However, they can be found around the world. Spotify is a Canadian unicorn, while these mythical companies have also popped up in China, the UK, Singapore, and Australia.
Are All Unicorns Tech Companies?
Not all unicorns are tech companies, but the vast majority of them are. For example, Devoted Health is a unicorn company in the health insurance business.
Unicorn stocks are intriguing. These companies create technologies or services that are so ahead of their time that they have the potential to change the shape of the entire sector in which they work. In doing so, they fly to billion-dollar valuations well ahead of their peers.
However, there’s a catch. Unlike the mythical creatures for which they’re named, unicorns in the market aren’t all perfect and beautiful. While some have the potential to generate significant gains, they also have the potential to generate significant losses.
So, if you’re considering investing in these stocks, instead of making a FOMO-based trade, take the time to do your research and seriously consider whether the technology that keeps the unicorn’s ticker ticking is something that you believe to be revolutionary. Dive into the company’s books, and make an educated decision for yourself as to whether the company’s billion-dollar valuation is justified.