2019 was supposed to be the Year of the Unicorn – when technology companies valued at more than $1 billion would finally, triumphantly, move en masse toward public listings. However, as WeWork’s recent botched IPO attempt and its aftermath demonstrate, the reality of the unicorn IPO has proven more complex.
For those U.S. unicorns that made the leap to the public markets in 2019, performance has varied widely, but a clear trend has emerged: Enterprise software unicorns have largely outperformed while those focused on the consumer sector have languished (Exhibit 1).
As discussed in our paper, Age Really Does Matter When It Comes to Unicorns, there are meaningful differences in the business models of these two types of companies. Enterprise-focused software companies largely follow a software-as-a-service (SaaS) business model, which has high up-front costs, but marginal costs that approach 0% as a company scales. As such, the path to eventual profitability for SaaS businesses is relatively well understood and driven by the addressable market and the lifetime value of a customer (primarily customer acquisition cost, duration of the relationship, and revenue generated).
The business-to-consumer segment, meanwhile, has several differentiated business models. Two of the more common are the advertising-driven model employed by companies like Google, Facebook, and Pinterest, and one that leverages technology to provide a tangible product or service (e.g., Chewy, Uber, and Lyft). For the second group, we noted concerns that these companies were not pure technology companies and that their profitability could partially resemble that of the very industries they sought to disrupt.
Public market investors appear to agree, as we have seen reflected in the share prices of these companies post-IPO. Driven by a “growth-at-all-cost” approach in private markets, many consumer-focused, tech-enabled companies delivered “profitless prosperity” for their private market shareholders. In the public markets, they have struggled to justify their valuations. Public markets have recognized these differences and largely chosen to award higher valuations to those companies with higher margins and a clearer path to profitability.
This discrepancy in how the private and public markets have approached valuing software-enabled businesses versus businesses in which software is the product has also not gone unnoticed by private market investors. This notion was most eruditely captured by Fred Wilson of Union Square Ventures in a recent blog post:
I believe that we have seen a narrative in the late stage private markets that as software is eating the world (real estate, music, exercise, transportation), every company should be valued as a software company at 10x revenues or more.
And that narrative is now falling apart.
If the product is software and thus can produce software gross margins (75% or greater), then it should be valued as a software company.
If the product is something else and cannot produce software gross margins then it needs to be valued like other similar businesses with similar margins, but maybe at some premium to recognize the leverage it can get through software.
But we have not been doing it that way in the late-stage private markets for the last five years.
I think we may start now that the public markets are showing us how.
It certainly seems that, in this corner of the market, at this moment in time, the brute efficiency of the public markets has led the way.
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