What Accounts for the Proliferation of Billion Dollar Startups?

Unicorns — startup businesses that are valued at at least $1 billion before going public — essentially did not exist before the 2000s. Their numbers have recently surged. These firms break with the traditional startup trajectory by going public later and at valuations far above those of other startups. They also attract late-stage funding not from venture capitalists but from large institutional investors who are more patient, more open to raising the large sums necessary for the firm to keep growing, and more willing to allow company founders and initial shareholders to cash out before the initial public offering (IPO). 

In The Unicorn Puzzle (NBER Working Paper 30604), Daria Davydova, Rüdiger Fahlenbrach, Leandro Sanz, and René M. Stulz find that of the 639 US startup firms that achieved $1 billion or more in valuations between 2000 and the third quarter of 2021, 427 remain active unicorns and 212 have exited. Among the exits, 137 went public, 110 through IPOs, 18 through special purpose acquisition companies, and 9 via direct listings. An additional 44 unicorns exited through mergers and acquisitions. Only 21 of the firms that reached unicorn status during the study period failed, either filing for bankruptcy or agreeing to a merger at a value below 25 percent of their unicorn round valuation.

Very valuable startup businesses are delaying initial public offerings and attracting institutional investors willing to fund their growth as private firms.

Many of the unicorns in the sample are still private, but for those that have gone public, the returns to investors have been substantial. The researchers calculate the returns to investors who provided capital in the “unicorn round,” when the firm was valued at close to $1 billion, for unicorns that have subsequently gone public. For these firms, which are clearly a select subsample, the average IPO share price was 3.7 times the price in the unicorn round, and the median realized return to investors was 1.6 times the coincident return on the S&P 500 stock index.

Compared to other startups, unicorns spend heavily on advertising, information technology, human capital, and customer relations. Three in five unicorns in the study’s sample distribute their products via the internet, where network and scale effects are especially important.

There is concentration of unicorns across lines of business and geographically. More than a quarter of these companies are in the business products and services industry, a sector that accounts for only 6 percent of all publicly listed companies. Unicorns are also disproportionately likely to be headquartered in Silicon Valley.

In the traditional world of venture-financed startups, an IPO offers a firm access to public markets, which enables it to raise funds to grow and to use its publicly traded stock to buy other companies. IPOs also enable startup owners to diversify their holdings by selling shares.

Unicorns delay IPOs because the type of businesses they are in make it more expensive to go public early. Unicorn status also reduces the benefits of going public as it opens the door to more sources of funding besides venture funding.

The researchers present evidence that the costs of going public sooner are particularly high for unicorns. Going public requires disclosures that are costly for unicorns because of their business model, which relies heavily on organizational capital and network effects. Their intangible assets take time to build and can easily be expropriated by competitors at early stages of development. Therefore, they are easier to develop and protect when a company is private.

The period under study ended at the peak of a bull market, which boosted valuations and led to the creation of some unicorns. Although the rate of creation has dipped as stock market valuations have retreated, the rate of unicorn creation in the second quarter of 2022 was still higher than in any previous quarters except the first three of 2021, which supports the researchers’ thesis that shifting business models are important factors in this trend.

— Laurent Belsie