Imagine you have finished your MBA and have decided to set up a business on your own. You have a great idea for a new product/service that you believe will fill a gap in the market. The only problem is that this will require money to get off the ground and you don’t have that much cash. However, you do have family and friends willing to lend money to get you started, so you go ahead and set up the business.
The business is successful and starts to grow quickly. You need more money, but your friends and family can’t provide the funds needed to get to the next stage of development. You pitch to angel investors and venture capitalists (VCs). They are impressed and give you your first round of proper funding. To get this cash you have to give up a percentage of the company. You had owned 100% up to this point. But no longer.
The VCs will take a stake in your company in return for the funding. At this point your company will have its initial valuation, based on the funding round. This funding will allow you to build the business much faster and roll the concept out regionally. How fast can your company grow at this stage?
Start-ups can be as small as a one-person operation, but if they can sell a compelling story to investors, a few might grow into billion-dollar businesses. How quickly do you think a start-up can make it from first-round fundraising to a valuation of $1 billion? Five years? Three years? Two years?
How about in less than 250 days? Two companies that recently managed to go from first-round funding to a valuation of $1 billion in that amount of time are Uptake and Magic Leap. Naturally, they are tech companies.
Uptake is a data analytics company that aims to be the ‘internet of things’ for industrial companies. Magic Leap is quite a secretive company and does not give out too much information, but it seems to have something to do with virtual reality. A third company has made it to this ‘unicorn’ status (valuation of $1 billion) in around a year. This is Zoox, which is involved in driverless cars.
Each of these companies is involved in cutting-edge technologies, which has led to the high valuations being achieved very quickly.
- The billion-dollar valuation status is achieved during follow-on funding rounds in which new (or existing) investors buy into the company. This involves the original owner giving up more of their share of the company.
- VCs are eager to jump on the Next Big Thing and are willing to fund companies that look to have the ability to create new products or markets. They are looking for future Facebooks and Amazons.
- Remember that, at the start, the budding entrepreneur has a 100% stake in a company that is worth something only in their own head. After the rounds of fundraising, their stake might be down to 50% or less. But that is potentially 50% of $1 billion.
Facebook was a start-up not that long ago. Mark Zuckerberg still owns 418 million B shares in the company, which represents about 18.5% of the stock. Facebook has a market capitalisation of $367 billion, so his stake is worth about $68 billion. During the start-up phase at Facebook, Zuckerberg gave away more of the company to get the funding needed to expand the business. Then it came to the stock market (and that is where the early investors cash out).
Magic Leap reached a billion-dollar valuation in less than 250 days, but not many people understand what it does. It still doesn’t have a product in the market and investors may be getting worried about the cash they have poured into the company. The last time companies raised huge sums so easily on the back of a concept (no product) was in the dot.com era (at the end of the 1990s), and we know how that played out…
Do you think the valuations for these start-ups will be justified?