Why Hunt for Unicorns?
We all know that startups are a high risk, high reward asset class. It’s a cliche in Venture Capital that, from a portfolio of ten startups, nine will fail.
This implies that the one “winner” needs to return the portfolio and provide the entire upside. So we hunt for “unicorns”: startups that deliver eye-watering, headline-grabbing exits.
According to data from First Round Review, startups only have a .00006% chance of achieving unicorn status. Hunting for them therefore can be a very high risk strategy that itself throws fuel onto the risk associated with Venture Capital. The headlines write themselves.
But what do the nine companies that “fail” look like – are they actually failures? Often, a “fail” in this context means that the startup is not potential unicorn material.
According to data from i5invest, 80% of EU exits are under €50M, and the average sits at €30M.
What if you didn’t need to chase the .00006% of startups that become unicorns? What if, instead, you could achieve returns by playing into the centre of the 80% of EU exits? This is where the Seed Enterprise Investment Scheme (SEIS) can step up for investors.
SEIS investments are often made long before a company hits a £1M valuation. (Here at Nova, our typical pre-money valuation for an SEIS stage company is £300K.) Investing at this early stage – not through friends and family, but through a well managed, proactive, FCA authorised fund – provides an opportunity for potential outsized returns. All whilst typically only having to play where the vast majority of exits are happening.
For example, if a company valued at £300K manages to exit at £30M, this would be a 100x return. You would only need that company to have an exit of £3M to provide a 10x return.
These £300K companies aren’t the headline-grabbing, £100M investments that most people are hunting for; rather, they’re successful small businesses solving niche market failures, having positive impacts on entire communities and creating extraordinary wealth in the process.
It’s important to realise that, in terms of stability, a startup with a £300K valuation is an inherently riskier asset than one valued at £100M. Investors can mitigate this risk by investing into a UK managed SEIS fund, which supports and nurtures a portfolio of such companies, spreading the risk and helping them address the main areas of failure. (Here at Nova, our approach has reduced the assumed failure rate of 92% within three years, down to 25% within our portfolio of companies.)
When you then consider the generous SEIS tax breaks that the UK government affords to UK taxpayers – potentially underwriting 86.5%* of each investment – this early stage asset class becomes compelling.
As VC investment continues to break new records, some of us are asking if we want to play in the .00006% world of unicorns, or if the 80% of €30M exits is a better bet. Why hunt for unicorns?
*based on higher rate taxpayers claiming full SEIS tax reliefs.