Researchers: Venture Capitalists Get Reputation For Being Insightful After 1st Unicorn But Almost Never Repeat Success

Researchers: Venture Capitalists Get Reputation For Being Insightful After 1st Unicorn But Almost Never Repeat Success


Credit: shutter2photo / iStock shttps://www.istockphoto.com/portfolio/shutter2photos?mediatype=photography

For a startup, the odds of attaining unicorn status — a $1 billion-plus investor valuation — are slim, and that’s an understatement. A business has a 3 in 5 million chance (or 0.00006 percent) of becoming a unicorn, and it takes an average of seven years for startups to grow into unicorns.

The making of unicorns is largely due to venture capital funding raised by startups in the form of financial, technical or managerial assistance. Funding usually comes from individual investors, investor groups, investment banks and other financial institutions. Investors expect equity in exchange for capital and startup owners take on some risk and disadvantage by selling shares of their company to a venture capitalist.

Venture capitalists who bet early on a company that becomes a unicorn get a reputation for being insightful after their first unicorn but almost never repeat that success, according to researchers.

As of July 2022, there are more than 1,100 unicorns — about 60 percent of them in the U.S. Some of the best-known examples of startups that became unicorns include Airbnb, Facebook and Google.

Low-interest rates of the past and high venture capital investment activity in 2020 and 2021 led to burgeoning growth of $1 billion-plus private companies but the big numbers of 2020 and 2021 have subsided in 2022. The most common unicorn industries include finance and insurance, technology and telecommunications, and transportation and logistics.

READ MORE: Number Of $1B-On-Paper Startup Valuations Collapses As Investors Step Up Scrutiny, Leverage

Venture capital investors who find a surprise unicorn early in their careers almost never find another hidden gem, but the early win gives them a reputation as insightful and thus they get better deal flow forever.

That’s the summary by a Wharton School professor describing the findings of a 2019 working paper titled “The Persistent Effect of Initial Success: Evidence from Venture Capital.”

In the paper, researchers from business schools at Harvard University, Yale and IESE studied performance persistence in venture capital.

The researchers found that choosing the right investment early almost never happens again in the world of venture capital. However, if a VC firm is lucky enough to be in the right place at the right time and invests early in a company that becomes a unicorn, each additional initial public offering among its first 10 investments predicts as much as an 8 percent higher IPO rate on its subsequent investments.

“Successful outcomes stem in large part from investing in the right places at the right times,” the researchers wrote. “VC firms do not persist in their ability to choose the right places and times
to invest; but early success does lead to investing in later rounds and in larger syndicates.
This pattern of results seems most consistent with the idea that initial success improves
access to deal flow.”

“This is literally true” tweeted Ethan Mollick, an associate professor of management at the Wharton School at the University of Pennsylvania. Mollick’s research focuses on innovation, entrepreneurship and “democratizing business education through games,” according to his Twitter bio.

The boom in unicorns in the last two years is not expected to last. Many unicorns, especially in tech, have been overvalued, which leads to venture capitalists losing out on the returns they originally anticipated, wrote Russ Zalatimo, a managing partner at HudsonPoint Capital.

An estimated one in 10 unicorns is overvalued, Zalatimo wrote in a Forbes column.