Unicorns blessed with big-buck fundings

July saw US fantasy sports competition company FanDuel raise a $275m series-E round that valued the company in excess of $1bn, awarding it the coveted status of unicorn. A month earlier, Spotify raised $526m in a series-G led by telecommunications firm TeliaSonera, valuing the Swedish music streaming business at $8.5bn.

These are just two examples of a trend that has been ongoing since 2014, whereby venture-capital-backed companies raise eye-watering funding rounds from private investors, shunning an IPO and public-market fundraising.

The funding rounds are indeed gargantuan, raising amounts of capital traditionally only possible in a flotation. In less than six months from December 2014, Snapchat raised more than $1bn in total, over three private funding rounds.

At full gallop
In a recent analysis titled US Technology Funding – What's Going On?, US venture firm Andreessen Horowitz highlighted a surge in private $40m+ funding rounds in 2014 compared with the previous two years, and a decline in public market fundraising.

According to Andreessen Horowitz's data, aggregate funding for the top 20 private US tech deals was nearly $12bn, compared with less than $4bn the year before, and a previous 18-year record of around $8bn in 2011.

By contrast, capital raised in the public markets for the top 20 US tech deals in 2014 was at its lowest since 2010, with approximately 50 IPOs raising a total of $10bn – the lowest volume since the early 1980s.

When asked if there will be an increase in European unicorn rounds as well, Hans Otterling, a general partner at Nordic VC firm and Spotify-backer Northzone, says this is a certainty: "What we're seeing right now is a lot of capital being reallocated to growth rounds, such as Spotify and other investments, in the private market."

Otterling points to the trend of mid-market buyout funds, such as EQT and Vitruvian Partners, launching venture-type, minority-focused and tech vehicles: "I assume their tickets are going to be significantly larger than series-A or series-B rounds," he says, referring to the size of the vehicles, "which means capital allocation is being refocused into growth companies."

His view is supported by Simon Cook, CEO of Draper Esprit: "There's a bigger picture where public and private markets are blurring," he says. "What's new is this mega option; these private mega rounds for unicorns weren't there in the past.

"Capital is globalised, and tech is widely understood, and you've got a blurring of public and private-market thinking at both ends," Cook says, pointing to crowdfunding as an example of a public market model of hundreds or thousands of shareholders funding small, private companies.

"You've got private companies raising small rounds with lots of shareholders, and huge companies raising large amounts from few investors," adds Cook.

"There's a bigger picture where public and private markets are blurring. What's new is this mega option; these private mega rounds for unicorns weren't there in the past."

Simon Cook, Draper Esprit

Public or private?
The availability of substantial later-stage venture capital affords some advantages over going public for rapidly growing companies.

More than anything, IPOs take a lot of time, effort and money. There are fees to be paid, shareholder allocations to be organised, compliance to follow and endless other factors that can distract from growing the company.

"It takes a lot of management's time to prepare for a listing, and that's taken away when you're in a private market," says Otterling. "Being private can be a huge advantage when you're in a very competitive, rapidly changing environment, where you can fund much faster [than the public markets]."

Likewise, having a select group of shareholders means the company is not burdened with stringent quarterly reporting, and it may find investors are more understanding when prioritising market share and revenue growth over turning a profit, as is often seen with fast-growing tech businesses.

Though a public share structure allows companies to pay for acquisitions using stock, staying private lets them maintain a more complex and flexible ownership structure, as opposed to a public market that generally requires all investors to fit in the same share structure.

Mythical money
However, there are also downsides to raising vast amounts of money privately. In an environment where many investors are hunting unicorns, the pressure to reach a $1bn+ valuation may see some companies overvalued, and subsequently saddled with unrealistic expectations they are unable to deliver. "A lot of companies that are pre-revenue today and have unicorn status have extreme expectations from the investors' side," says Otterling. "Sometimes that's just not healthy, but you have to look at it case-to-case."

Private-market unicorn valuations are always more likely to be scrutinised by analysts, investors and the media, trying to determine if the valuation is justified, or the result of irrational exuberance, hype or something more sinister. Arguably, the public markets are in most cases able to find a broadly accepted fair value.

Ultimately, the public-versus-private question comes down to the individual company. At Fortune's recent Brainstorm Tech event, KKR co-founder Henry Kravis was asked whether the concerns of privately held tech companies' CEOs about going public were legitimate. "I'm not going to tell any company they should go public," he said.

"If you've got a good company – in the environment we're in you can raise a lot of money, so you don't have to go public," said Kravis. He advised companies to hold off on IPOs until it is a necessity, to avoid the pressure of quarter-to-quarter earnings, which he called "the worst thing to happen to corporate America", because it favours short-term thinking over long-term decisions.

No IPO KO
Despite the emergence of private-market unicorn rounds, and a drop in the number of billion-dollar flotations, the IPO's demise is overstated.

The public market is still a viable and well-used funding route for mid-market companies, underlined by a record year for public listings in Europe in 2014, which saw 58 sub-$1bn private equity and venture-backed IPOs – the highest since 2007.

"Outside of the world of unicorns, there's still the herd of wildebeests," says Cook. "We still see plenty of IPOs of healthy mid-sized companies."

Cook does not believe there is a trend towards moving away from public markets and towards big private deals, but rather a tendency of investors wanting to capture more value on the private side.

Given the venture capital available and the risk profile of investors in the current market, backers are willing to take on risk that would historically have been spread in the public market. Venture rounds of $100m+ were not an option for companies in the 1990s, and businesses including Oracle and Amazon went public at valuations below $1bn, but went on to achieve unicorn status post-flotation. Amazon, as well as Microsoft and Oracle are among the tech giants that created the majority of their value in the public market.

The increase in large late-stage funding rounds may ultimately result in a change to the classic VC fund structure, says Cook: "What's going to come out of this is a challenge to the 10-year LP structure. I think we've seen the peak of it, because investors are holding on to these funds as long as possible to capture that value."

"I think we're in a cycle and we'll see this pendulum going back and forth between being private and going public, but there are obvious advantages in both markets."

Hans Otterling, Northzone

Dragon age
While unicorns and their funding rounds are receiving a good deal of attention, venture capitalists have begun hunting a new mythical creature: the dragon, or companies that have returned liquidity to investors at a $1bn+ valuation. These include firms such as Facebook and WhatsApp.

"We as an investor are ultimately in the business of sending money back to our LPs," says Northzone's Otterling, who is indifferent to whether returns are created from public or private exits.

With record levels of dry powder on corporate balance sheets, trade sales remain an attractive exit route for many companies: "If we can get liquidity by selling our equity to other private players, that's a good alternative as well. I think we're in a cycle and we'll see this pendulum going back and forth between being private and going public, but there are obvious advantages in both markets," Otterling says.

In the end, many of the biggest multi-billion dollar businesses will likely end up listed, as there is no reason for them to not be public, according to Cook: "Ultimately they will have to go public to return capital to those investors. I think being public is the right place for the biggest companies."

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