In 2013, Aileen Lee, the founder of a Venture Capital company by the name of “Cowboy Ventures” coined the term unicorn to refer to a privately held start-up with a value in excess of $1bn. The implication was, and still is pretty clear. That these companies are so rare as to be almost mythical. The term caught on, and is now in common usage.

But unlike actual unicorns: magical horses with horns, these tech start-ups known as unicorns actually do exist, and their numbers are growing.

What is a unicorn in the tech world? 

When someone refers to a unicorn in the tech world most people immediately picture companies like Facebook, Google, or Amazon, but none of these tech behemoths actually fit the criteria as they are no longer in private ownership.  But they were once. And in reality there are many more companies that are classed as unicorns that you probably haven’t heard of.  A company can be worth only a small fraction of Amazon and still be a unicorn

So let’s actually break the numbers down.

There are many different ways to put a value on a business, and in reality unless someone is willing to pay it then it is just a vanity number. It’s also worth bearing in mind that valuations are usually based around selling a small amount of your company and it’s not always the case that you could find someone to buy the rest at that price!

For the purposes of this article we will take one of the simplest that is often applied when valuing SaaS business:.  An arbitrary multiple of annual revenue.

Justifying the multiple is the trickiest bit, and there is a wide variance based on the kind of business you have but they typically range from 5x-20x (although some can command 40x or more if they are especially hot tickets)I’m not going to go into this here as it deserve sits own article (I’ll hold you to that - Ed), so for the purposes of the example I’ll pick one from somewhere in the middle - 10x

So with that in mind a company commanding a 10x multiple needs Annual Reccuring Revenue (ARR) of  $25M to justify a valuation of $250M.  $25M multiplied by 10 equals $250. To get to a $1Bn valuation would mean ARR of $100M.

Obviously we are ignoring all the important stuff like EBITDA, actual profit, projected growth, weighted pipeline, perceived future competition and so on, but while an annual revenue of $100 is an astonishingly big amount, it definitely isn’t so big as to be mythical.

How many unicorns are there?

It’s not an easy task to try to work out how many unicorn tech companies there are in the world, but According to CB Insights, a research firm that tracks private companies, investments and acquisitions, at the time of writing there are 837 companies that fulfil the criteria of being a unicorn globally, Embroker.com puts the number at 554. While those are quite different numbers it points to there being hundreds, maybe over a thousand such companies.

Here in the UK, Beauhurst - lists 34 companies with a value of over $1Bn that are still privately owned.

How do unicorns grow?

There is no one method for growing a company to unicorn status, but there are a few things that are true for the vast majority of companies that have got there, at least during their high-growth phase.

1. They have nailed product market fit.

2. They have a product that is perceived as an effective solution to a genuine problem.

3. They have good people who can execute on their goals.

4. They are built to focus on growth rather than profit

5. They focus on doing one thing  as well as they can

6. They are persistent yet can move quickly when they need to
   

Are unicorn companies profitable?

Profit often isn’t  the focus for a company on the path to unicorn status. At least not during the growth stages. They tend to focus on perfecting the product, and growing market share, and revenue.

Nutanix, a tech company that hit unicorn status in 2013 did so without any profits at all.  But their product was good enough, their vision clear enough, and their ability to deliver solid enough that investors were happy anyway.

What are the odds of starting a unicorn?

This is where we come crashing back to earth. The chances of you starting a company and becoming a unicorn are somewhere between extremely small and non-existant.

There were 4.2 million companies on the UK register at Companies House at the end of 2019. Even if we assume this number has remained stable (it hasn’t, it will have grown, it does every year but the government don’t release the stats very quickly) then the ratio of unicorns to limited companies is 1 in every 123,529.

So the chances of your company becoming a unicorn are not great. But as we said at the start, these unicorns do exist, and just because the odds are stacked against you doesn’t necessarily mean you shouldn’t aim high.

Is it worth trying?

If all you care about is owning a company that is worth a billion dollars then I’d probably advise you not to go down this route. 

It is not an easy path. It requires sacrificing your family life, your friendships, any hobbies you may have, and at the risk of sounding dramatic, everything you hold dear in service of a business that will probably never get where you want it to get to.

But that doesn’t mean you should give up on the idea of the business.

In fact I’d probably go as far as to say that if you stop focusing on the unicorn status, and just try your very best to build the best business you can, that solves a genuine problem for as many people as possible then you are actually more likely to get there.

After all, Facebook wasn’t originally set up to make billions. It was set up to help people from university connect online.  And it did that so well everyone else wanted to get involved.

When we spoke about the different types of investment I raised the subject of share dilution and promised that I’d explain it in detail later. For the purposes of this article when I refer to shares, I am talking about common shares, not preferred shares (You are going to cover the difference one day right? - Ed)

Well it’s later, so here goes.

Shares are units of ownership of a company, or equity in the company. If you were to found a company by yourself you would own all of the shares and hence the whole of the company. If you started a company with two other people and issued three shares, one for  each of you, you would all own one third of the company.

What are diluted shares?

When you come to raising money the concept of dilution becomes central. It refers to the dilution of ownership of the existing shareholders when new shares are issued. Why are new shares being issued? It’s because you raise money for the company by selling those new shares to investors. If you were selling existing shares the money would go to the shareholder, which benefits them, but doesn’t put money into the company.

The amount you raise is the new share price multiplied by the number of new shares you issue. To expand on our example above each of our three founders owned 33.3% of the company, and had the equivalent voting rights. However if the three founders wanted to raise some investment into the company in order to scale quickly, they might look to give away 25% of the company’s equity in return for the investment.  That would mean they would issue one more share, and that would go to the investor.

Each of the now four shares still have equal value, but when there were only three, each was 33% of the company. Now there are four, each is 25% of the company.

By adding an additional share the original founders have diluted their ownership of the business. However if the new share price is high enough the value of their shares may have risen, after all  25% of £200,000 is worth more than 33% of £100,000.

Let’s take a more realistic example:

Three founders share a business equally holding 1,000,000 shares (each with a nominal value of £0.000001, a fairly typical arrangement).

They want to raise £60,000 so go out to investors. They set a pre-money valuation of the business at £675,000 (based on their claim of value generated so far).

They sell 266,669 new shares to new investors at a price of 22.5p each (£0.225 * 266669 = £60k) Since there are now 3,266,669 shares in the company their original 1,000,000 shares now represents 30.6% percent of the company rather than 33.3%. However the business is now worth £735,000 and the value of their shareholding has risen from £1 to £224,000! 

What happens when shares are diluted?

The key thing to understand about share dilution is how it affects majority ownership of the company. In our example above, while none of the 3 founders owns a majority of the shares, together they still own over 90%. Some issues (for example the issuance of new shares) require an investor majority. As the ownership level of the founders reduces, the influence of other shareholders increases. Different levels of share ownership also bring different rights (a topic for another article) but the key thing is to keep an eye on the majority.. 

The other thing that is worth mentioning is that each share, in additional to its voting rights, also brings with it a share of the profits of the company should it issue dividends. Startups often don’t issue dividends but more established companies typically do. So when shares are diluted, the portion of the profits are also diluted, although if the business is becoming more profitable then the share of profits may still increase.

Why share dilution can happen

There are all sorts of different reasons why share dilution may happen.  We’ve already  covered equity investment in the company, but  other situations may also create dilution. 

It’s typical for employees in early stage companies to be offered share options, those shares are also dilutive. And if a company acquisition is made, shares in the purchasing company are sometimes offered as part payment to the shareholders in the company that has been purchased.

In effect, any time new shares are issued, then existing shares are diluted. 

Is share dilution a bad thing?

Well that depends entirely on your perspective. If what you care about is the ability to make a decision about your company without having to involve anyone else then diluting your power to do that is by definition a bad thing.  But when it comes to the base finances it may not be that bad a thing at all.

Diluted earnings by share

When you look at share earnings as a percentage of the profits then share dilution has a significant impact on earnings.  But if you look at the amount of earnings in monetary terms then it is rarely that clear cut.

As a rule reasons for issuing extra shares are considered positive for the company. Bringing in investment signifies future growth, and so the raw value of any share will increase.

Let’s go back to our example from earlier.

Our three founders all have 33.3% of the company, and so if we value the company at £1M they all own £333,333.33 in monetary terms.  If that company makes 10% profit which is paid out as dividends (not a likely number, but nice and easy for the maths) then each of the three shareholders will take £33,333.33 in dividends before tax.

However if an investor believes the company will grow, and offers £500,000 for their 25%, then it would be fair to value the company at £2M, meaning each 25% share is worth £500,000. A lower percentage, but a higher figure.

If that investment is used wisely, and the company does double in size (but surprisingly still makes exactly 10% profit) each of the now four shares would attract a dividend of £500,000.

Again, the shares have been diluted, but the money has grown.

So in the simplest sense, if the reason for the dilution increases the value of the company, the dilution of share value may not reflect in the financial value of the shares.

Alternatives to share dilution

Share dilution mostly arises out of equity investment and typically makes sense in a company that is growing and building value. If the shareholders don’t wish to dilute it may be possible to raise money through, for example, raising debt.

It sometimes happens that shareholders will sell some of their existing shareholding. When this occurs the money goes to the existing shareholder, not to the company. This is sometimes referred to as a secondary sale and is sometimes used to allow founders to cash out before an IPO and without diluting the company.

The dangers of dilution

There are no hard and fast rules about dilution, but you need to be aware of the possible impact share dilution can have on your position within your company. It is not unheard of for a founder to find themselves being forced out of the role they had in their own company by investors who now had a controlling share.

You need to be aware that with very few exceptions, investors are not there to protect you, they are there to make money, and while a small percentage of a fortune is still a lot more than all of nothing, dilution can have a huge impact on you and your business. 

Dilution is a complex subject, and there are subtleties I don’t have the space to cover here. You should definitely be aware of and take professional advice before making big decisions that may trigger it. But as long as you keep in mind how it affects your majority, and keep building the value of your company it’s nothing to be afraid of.

Investment is a subject that comes up a lot when I am talking to people in the early stages of setting up their business. And on the assumption that you are looking to build a tech solution for your business to sell, you aren’t a skilled enough coder with bucket loads of spare time to be able to build it yourself, and you don’t have large amounts of money sitting in the bank that you are willing to use to fund it. Then it is a subject you need to know a little about.

But investment comes in a variety of different flavours, and not all of them are going to be palatable to you. (Interesting choice of metaphor there – Ed)

The first thing that I need to say is that whatever type of investment you are looking for, accepting it will involve you giving up some of your independence, and mean that to one degree or another, you are going to be accountable to someone else.

Short of a lottery win or a benevolent elderly aunt who happens to be sitting on a fortune and just wants to make people happy, accepting money means both increased expectations and reduction of control.

What you are expected to deliver can vary hugely though, so let's take a look at the broad categories of investment and what they might mean for you.

Angel Investment

An angel investor, commonly known simply as an “angel” tends to be a high net worth individual - In essence someone who has quite a lot of money.

They tend to invest relatively small amounts of their own money into businesses during the early stages of those businesses. They do it because it interests them, because they want to give back, or because they want to make more money without doing the hard work of starting a business.

They usually either want direct equity in return for their investment, which in essence means giving up a share of your company at the beginning.  Sometimes however they may wish to exchange their money for “convertible debt”. Which is a fancy way of saying that they’ll switch the money you owe them to shares later when the shares are worth more.

There is a broad spectrum of angels. Some make very few investments, some make a handful and a few will make 10, 20, or more. A typical angel makes a first investment of between £5,000-£25,000 although a few will go higher and many will follow on for larger amounts in future rounds.

Because they tend to be investing in early-stage companies angels are often investing as much in the founding team as the business per se. Angels are very high risk investors and many will be inclined to try and get their money back as quickly as possible to re-invest.

The downside to angel investment is that the more money you need to raise the more angels you need to persuade to join your round. Wrangling angels can be hard work and take a long time which is a distraction from working on the business..

Venture Capital

Where angels invest their own money, the partners (often known as VCs) of a venture capital fund are investing money that has been raised from a group of other, passive, investors such as ultra-high net worth individuals, hedge funds, pension funds, and family offices.  They tend to invest later in the life of a business than angels, often at the point where product/market fit has been established and a large cash injection is required to grow the business fast.

Because VCs are investing other people's money, their relationship with any given investment and founding team is different to that of an angel. A VC may want to be on the board and is much more likely to interfere in the decision-making of the company. 

If you put your money in a bank right now you’d be lucky to get a 3-4% return. The same money put into an S&P 500 ETF fund is likely to yield, over time, about a 10% return on your money. To persuade their backers to give them the funds a VC has to promise to do better than that. To that end VC funds claim that they will return 2-3x the fund value in 10 years. The good ones can do this but, typically, that is about 5% of all funds. More than half will struggle not to make a loss.

A large proportion (in some studies over 90%) of startups are going to fail. Which gives VC’s a problem: if 9 out of 10 of the businesses they invest in are going to fail, they need that one success to return 2-3x their fund. If you’ve raised a £500m fund then you need to exit that company for something like £1.5bn. But you don’t know which of your companies is going to be that one so you have to look at all companies through the lens of “Could you be the company that will be big?”

Simply being a good, profitable (even wildly so) business is not enough.

This is a massive subject and one we will look at in more detail, but what it means for you, is that you can find your investors disagreeing very strongly with you if they think you are looking to make decisions that may stop them getting the returns they need.

The downside to VC funding is that it is extremely difficult to get for brand new organisations. Not impossible, but it’s far from a sure-fire option.

Crowdfunding

If finding investors doesn’t sound appetising then a crowd fundraise can be a viable option either to fully-fund your business or to fill out a larger raise.

The key advantage is that the platform brings the investors to you. However, it’s not all good news as these platforms are increasingly busy meaning that your opportunity may find it hard to cut through the noise. Further, the quality of investors on a crowdfunding platform is very variable and you can end up with a lot of small investors that will cause headaches down the line.

It bears mentioning that there are two very different forms of crowdfunding.  There is true business investment of the type offered by Seedrs and Crowdcube where you give away small amounts of equity for equally small investments, and there is the type of funding facilitated by sites like Gofundme, and Kickstarter where you can offer any reward you want in exchange for money (within reason). The commonest thing is to sell your “product” in advance, and use the money to help build the company.  In reality, these are customers and not investors, so while you will have a relationship with them, they don’t own any of your company, and your relationship with them is quite different..

In Summary, there are a lot of different approaches to sourcing investment for your business. These will differ depending on exactly what type of business you are running, what stage your business is at, and where in the world your business is based.

I’ve worked with a lot of people as they searched for, and secured, investment. If that kind of experience might be relevant then please come tell me about your opportunity and we can see what might help you.

We looked recently at the reasons you are building your business, and as I said at the time that is probably the most important question you can ask yourself (Or that we can ask you – Ed), but it is very much only the beginning of the process clients go through when they work with me.

One of the next things I’m going to be asking is what journey do you want to have?  Because let’s face it there is not one single path that you can take. If there was, my role of navigator would be utterly redundant. But just like all of these questions, it is not a simple one to answer, and most people need at least a little guidance as to what the options are. What types of journey are even possible?

So before I get on with talking you through that, I better explain the assumptions that I am making at this point.

I’m assuming that you have had an idea for a business, that you have worked out what problem(s) you are going to be solving with your business, and that you have identified, at least broadly, who your customers are going to be.

If that’s a fair description, then let’s get on with it. We’re going to start at the end.

What is your exit point?

Is your goal to create one of the almost mythical tech unicorns? A company to rival Google, or Facebook? Because it’s probably safe to say that Google and Facebook weren’t created to be the behemoths they have become.  And so if it is I’m probably going to suggest that you rethink.  While it is theoretically possible to end up with a company worth a sizeable proportion of a trillion pounds, the chances are so remote as to be almost non-existent.

Maybe your goal is to get to the point where you can sell or float the company and walk away with a few million or considerably more? That’s slightly more feasible, but as the voice of reason here I am honour bound to point out that companies of that size are still quite rare and hard to build.

Let’s go back a stage, and look at the options in their broadest sense.

Are you looking to build a company with the end goal of selling it for as big a lump sum as you can walk away with?  Or are you looking to create an organisation that you are not only proud of, but want to stay as part of? Is it going to be a one off windfall, or a comfortable lifestyle business?

The answer to that question is going to play a fairly significant part in how you attempt to grow your company.

Once you have a rough idea of what “finished” looks like then we need to look at how you might get there.

The first thing I’d want to know is do you have a timescale?  And if so, is it realistic?  We’d all like to come up with an amazing idea, and then sell it a day later for a billion pounds, but if that is your goal then you’re probably better off sticking to lottery tickets.

Do you have any money to invest in the business?  If not, are you going to be looking to source money from external investors?  If so, do you understand how investment actually works? Do you understand things like dilution?

That the more money you need to raise, the less of your company remains yours. It’s actually a little more complicated than that, but we’ll cover the details in a different article.

If you have investors already lined up, what are they looking to get back for their investment?  Are you giving away a share of your company? And if so how much? Will that affect the chances of you securing further investment in the future if you need it?

Are you looking to employ staff? And what role are you planning on taking on in the business?  Are you the tech brain behind it all, or are you the evangelist who is best suited to marketing and selling the concept.  If the latter, do you have a CTO in mind, or do you need to find one?  There probably isn’t a more important role in a growing tech start-up, so you’re going to need to get that right.

What is your business model? You do have one don’t you? Are you selling a product or a service? Are you billing as a one off, or are you signing customers up to pay monthly?

Are you the sole founder, or do you have other co-founders in place?  If not, do you have non-execs lined up to sit on your board to ensure you have the full range of expertise you are going to need?

While your business is still in its infancy how often are you going to get feedback on the products or services you are developing?  Once it is up and running smoothly are you going to be set-up for honest customer feedback?  Will you have structures in place to act on it if you need to?

Since the Pandemic hit one of the biggest questions a lot of founders are facing is will your business be remote, or will you be based in an office?  Perhaps you’ll adopt a hybrid approach with a bit of each. If that is what you have in mind where will your office be, and how will you ensure the remote staff feel valued members of the team?

How will you hire staff? Are you planning on doing it yourself initially? Or have you included the financial costs of paying recruiters to your cash flow predictions?

How close to the wind are you planning on sailing?  You can’t run a business without taking risks, how much risk are you willing to take?  And do you have a plan b just in case it doesn’t work out the way you want?

Even now, almost a thousand words in we have only just scratched the surface of what you need to consider to ensure the journey you go on is close to the one you want. In my experience company founders often don't think about it, they essentially reinvent the journeys they have experienced in other companies. But in reality there is a lot of room for intent that often goes unaddressed. I genuinely believe planning your journey is as important, or even more, important than "coping with your journey".

If you want to talk about your business journey, and how to make it go the way you want then drop me a line.

A sunk cost is something you have spent that is gone and you cannot get it back.  It’s a concept we are all pretty familiar with. But it doesn’t have to just be money.  It can be anything of value.  It can be your time, it can be favours asked for and received, it can be financial expenditure.  Anything that has a cost to you that you cannot recover can be classed as a sunk cost.

The sunk cost fallacy involves making future decisions based on irrecoverable costs rather than on whether what you are about to spend is the best choice now. It is allowing what is past to dominate what is future. We shouldn’t do this and yet, all too often, we do.

You may recall from our article on assumptions that there is a concept known as a heuristic.  A mental shortcut we take to help us make decisions quickly.  A way we stop ourselves having to go through the mental effort of making a decision from scratch, weighing every piece of evidence against the others every single time.

The sunk cost fallacy is one of the most damaging heuristics that we are all prone to falling victim to from time to time.

Let me give you an example..

A person starts a company and invests all of their savings into developing a proof of concept, a minimum viable product that shows that the problem they are looking to address is indeed solvable.

They take that MVP to a number of investors and eventually get the financial backing they need in order to develop it into a fully functioning product they can hopefully go on and sell.

Only as the product development goes ahead, and more and more of the investors’ money is spent it begins to look like early testing suggests that users are not responding well and do not see the value.

At this point our fictional founder has some decisions to make.

Do they push ahead despite growing evidence they have gotten the product wrong after all they have spent a fortune on getting where they are and they might as well finish it now they are so close?

Or do they stop, re-assess the situation in as objective a manner as they can, and make an informed decision as to what the best course of action is? And where that action, painful as it seems, might be to go back to the drawing board and start again?

Clearly the latter is the better idea, but the former is much more likely.

From the sidelines looking on it's easy to see that they should stop and reassess. But for most people when they are in this situation it becomes a lot more difficult. Walking away from what we have done is is hard. We have formed attachments. We've spent all this time & money. Surely it can't be that bad…"

And in a lot of ways those are all reasonable things to think.

If they are guided by actual evidence and not simply the desire not to have to write off the money already spent.

The sunk costs.

Let me try a different example.

You get out of bed one fine summer morning and head downstairs to make a cup of coffee.  On opening the cupboard door you realise that you are actually out of coffee. So you throw some clothes on and set off walking to the shop.

Only when you are almost there, you remember that the shop is closed.

Do you stop walking and then either go home or to a different shop?  Or do you keep going to the shop you know is closed because you might as well, you’re already most of the way there. It’d be a waste of all that walking if you didn’t finish what you’ve started.

When we frame it that way, it becomes pretty clear that a sunk cost is absolutely no justification for carrying on with something.

Yet we all do it.

We’ve all finished what was on our plate even though we were kinda full already. 

Those of us that are old enough to have used actual phones have carried on listening to the phone ringing at the other end knowing full well no-one was going to pick up and I suspect that I’m not the only person to have sat through a movie I wasn’t enjoying because I had already paid the ticket price.

The sunk cost fallacy is everywhere, and it is more prevalent than ever in the world of tech  start-ups.

Perhaps you have employed someone who clearly isn’t working out, and rather than making the tough, but undeniably correct decision to let them go you stick with them because it was an awful lot of work to get them in the first place, and you’ve paid them quite a lot so far.

Perhaps you are marketing your product using Google ads and they are not working out to be as effective as you were initially hoping?  Do you stop. Or do you keep paying because you're already invested so much and… maybe it will get better?

Perhaps your business is right at the very start of it’s journey and you have invested several thousands of pounds into consumer research to see if your assumptions about your idea are correct. Your product is not selling well. Do you go back and explore where you went wrong and change things? Or keep investing in along the same lines because you can't change courses now?

It’s not an easy thing to discount any sunk costs before making a decision. Accepting those costs are actually lost is a tough thing to do. None of us want to appear wasteful, and there is another heuristic at play here as well. That of optimism bias.

But that’s a subject for another time.

If you’d like to have a chat about your business and see if I can help you navigate past some of the many pitfalls that exist for the unwary please get in touch.