Some industry insiders are starting to wonder whether unicorns will hold their sky-high valuations — currently a combined $1.08 trillion — or crash to earth, bringing investor returns with them.
The questions come at a time when a number of these companies — startups valued at $1 billion or more — have signaled their intention to go public in 2019, racing to offer their venture capital backers a return should public market volatility ramp up more.
"Valuations have gotten extraordinarily high and people are wondering how long the great run is going to last," said Heidi Mayon, Redwood City, Calif.-based partner in the technology and life sciences group of law firm Goodwin Procter LLP.
Expected investor returns are based on valuations until an exit, and those valuations are based on successive rounds of financing, said Steven N. Kaplan, the Neubauer Family distinguished service professor of entrepreneurship and finance at the University of Chicago.
"Before companies are sold or have an IPO, it's a mark," a point-in-time valuation of the company, "and I don't know if the marks will come in or not," Mr. Kaplan said.
While a tiny sliver of institutional investors' portfolios, venture capital investments can sometimes deliver handsome returns. According to a 2017 report from Preqin, the most recent, venture capital funds — vintages 2007 through 2014 — with unicorn portfolio companies delivered a net internal rate of return of 18% compared to 13% IRR for all other venture capital funds.
Unicorns have become a force to be reckoned with in managers' portfolios. In 2018, unicorns raised a combined $44.5 billion, accounting for 33.9% of total investments by venture capital firms, according to the fourth-quarter 2018 PitchBook-NVCA Venture Monitor.
But unicorns aren't exclusive to venture capital funds, appearing in the portfolios of private equity firms such as Technology Crossover Ventures, multiasset-class alternative specialists including KKR & Co., middle-market buyout-growth equity fund TPG Growth and traditional money managers such as T. Rowe Price Group Inc., Fidelity Investments, BlackRock Inc. and Goldman Sachs & Co, according to a list by data platform CB Insights.
Graham McDonald, Edinburgh-based head of private equity at Aberdeen Standard Investments, said he, too, is not sure if the unicorn story will end well.
"I get nervous when I see (unicorn) valuations," he said. "Where does it sit with the wall of capital chasing venture capital and other companies staying private longer?"
He said he wonders if venture capital dry powder is keeping unicorn valuations high. "There will be some kind of correction at the top end," he said.
"We are living in a world where we see more IPOs with negative EBITDA (earnings before interest, tax, depreciation and amortization) in history."
Aberdeen executives are "watching with interest" whether negative EBITDA can be reversed, he said.
Unicorn investments will "end very poorly for many ... there are flowers in the garden but a lot of weeds, too," said Steve Rosen, Cleveland-based CEO of private equity firm Resilience Capital Partners.