Art Valuation

In the world of venture capital, there exists a special class of startups that attracts the attention of investors from nearly all backgrounds: Unicorns. These firms consist of private startups that are worth at least one billion dollars. The taxonomy goes further in order to identify the truly massive startups called “decacorns,” referring to their valuations in excess of $10 billion. Companies like Uber, Snapchat, AirBnb and SpaceX are among the best-known unicorns.
Conversations about the size of the valuations seem just as ubiquitous as the companies themselves. Headlines read of Uber’s $62 billion valuation, which easily surpasses Ford’s $50 billion market capitalization, and of AirBnb’s $25 billion valuation, which similarly trumps Hilton Group’s $22 billion market capitalization, despite having only eight percent of its revenue. In response to these astonishing sums, skeptics reverse engineered the growth expectations via traditional valuation techniques and found that, with astonishing frequency, unicorn valuation depends purely on optimism. Optimism, however, is not a new element in Silicon Valley’s expectations or in inflated valuations. The cause for this trend in inflating valuations is best explained by the changing nature of venture capital as it pertains to unicorns, and as a consequence, it is clear that valuations do not attempt to represent concrete value.

New considerations have been included into the valuation calculus. Average funding round size has increased dramatically in recent years, with some suggesting that “Series A round is the new Series B round,” referring to the notion that funding typically increases in each successive round. Over the course of 2014, average Series A funding rose 6 percent, Series B rose 20 percent, Series C rose 31 percent and Series D rose an astounding 100 percent. The increase in Series D funding picks up on a new strategy used by technology companies like Uber, in which mature companies stay private for longer and sustain operations with large, late-stage funding. Indeed, part of the inflation trend is due to the prestige of unicorn status itself, which is evidenced by the fact that Fortune Magazine lists just fewer than 100 companies that have valuations of one billion dollars, out of a total of 229 unicorns. CEOs and investors may see a startup’s unicorn valuation as a way to legitimize the company, attract new talent and over time, justify the overly ambitious valuation. Another part of the valuation inflation is due to the popularity of “downside protection provisions” as elements in funding agreements that shield investors from risk. For example, senior liquidation preferences are one common downside provision, and specify that an investor has its investment returned before other preferred stock or common investors should the company be liquidated. Another common downside protection is a provision that guarantees an investor additional shares if the company raises funds based on a lower valuation, thereby preserving the value of the investor’s stake in the company. Such stipulations have been increasingly popular as a method to shield against risk from investors, which consequently frees investors to make larger investments. As a result, it is clear that the inflation seen in valuations of unicorns represents the fact that the valuations are not pricing risk accurately.

Notable individuals from the worlds of technology and business have voiced concerns over some outlandish calculations. Jim Breyer, prominent investor and partner at Accel, a venture capital firm in California, commented early this year that he expects only 10 percent of current unicorns to survive and the remaining 90 percent either to fail or be revalued. Assuming his estimation is correct, only about 23 companies have accurate, or at least sustainable, valuations. In fact, skepticism is not uncommon. Bill Gates is wary of the future of unicorns as well, and warned of “overenthusiasm” in startups during a February interview with the Financial Times.

Regardless, some investors remain bullishly optimistic on unicorns. Scott Kupor, chief operating officer at venture capital firm Andreessen Horowitz, attempted to disabuse skeptics of the notion of a second tech bubble in a presentation this past year. He highlighted several key differences between 1999 and today, most notably the dramatic increase of Internet users (900 percent), the amount of funding (only 32 percent of the 1999 level) and the much lower median time to IPO (four years today versus 11 then), among other metrics. Evidently, he failed to convince many of his colleagues. A survey of 500 startups conducted by First Round Capital found that 73 percent of responders affirmed the existence of a technology bubble. The proportions of this bubble do not approach the frenzy of the late nineties, but there still remains an implicit understanding between startup owners and venture capital firms that valuations do not exactly equal value.

These mismatched valuations explain in part the scarcity of technology sector IPOs in 2015. Once public, markets will decide the true value of companies, so startups need to delay public offerings until fundamentals can support IPOs that reflect private valuations in order to protect investor value. Both Box, a cloud storage company, and Square, a payment service company, went public with offerings priced below their private valuations, providing a cautionary tale for executives and investors at other unicorns who have their eyes on the public market.

Like the valuations themselves, the disagreement over the existence of a second technology bubble can only be decided by the market itself in the years to come. Many of these unicorns have indeed reached incredible sizes with incredible speed. In seven years, Uber became the world’s largest taxi provider; it took AirBnB eight years to become the world’s largest hotel-provider. Perhaps it seems likely that the upper-echelon of the “decacorns” has substantial overlap with the ten percent mentioned by Jim Breyer. Yet, considering the 100 or so startups that may have wrangled for a billion-dollar valuation only for the title, many unicorns are simply overvalued, despite the “enthusiasm” attached to their future prospects. Silicon Valley and its bankrollers ought to remember that while enthusiasm is a critical asset for any startup, it is only as valuable as it is monetizable.

The mention of “Africa” typically does not echo back notions of “technology,” “innovation” or “entrepreneurship” in the minds of many people. Many countries within the continent are still associated with ideas of war, poverty and famine – but this is an incomplete story.

The so-called millennial generation is reshaping Africa’s entrepreneurship culture one startup at a time, with 90 tech hubs having already been established. Unlike previously when young talented entrepreneurs left their home countries, there is a greater incentive now for entrepreneurs to stay and establish their own companies.

“There is a paradigm shift [in Africa] from seeking employment or the opportunity to leave the continent to creating a future with opportunity,” Eric Osiakwan, co-founder of Angel Fair Africa, which invests in high tech and high growth ventures in Africa, said.

With a flurry of new startups and capital raising occurring on the continent, Africa has the potential become a hub for social entrepreneurialism that can support pioneers and help solve socioeconomic problems that hamper its growth and development.

Today, many African countries face critical socioeconomic issues, namely high rates of poverty and unemployment, and widespread inaccessibility to education. According to Gallup World, the ten countries with the highest number of residents living in extreme poverty, defined as earning less than $1.25 per day, were all from Africa. The World Review predicts that, by 2020, Africa will have more than 122 million jobseekers. These statistics demonstrate the need and market opportunity for entrepreneurial projects that will reduce unemployment, boost the continent’s economic growth and mitigate its socioeconomic problems.

Fortunately, there has never been a more willing generation of young Africans. The Future Awards Africa, an annual award ceremony that spotlights young Africans who have showcased exceptional vision, passion, and commitment to a social or developmental cause, received close to 800 nominations for last year’s count of Africa’s brightest young entrepreneurs below 30 years old. For instance, Alain Nteff, concerned by the high mortality rate of pregnant women and newborn born babies in his own local Cameroonian community created an app called Gifted Mom that helps mothers and health workers calculate due dates. According to Forbes, there has been a 20 percent increase in antenatal attendance rate for pregnant women in 15 rural communities due to the takeoff of the app.

Other impactful African startups include Eco Shoes Projects, which sells crafts made by artisans with disabilities, SunSweet Solar which builds inexpensive small-scale power plants for Tanzanian homes and businesses and Njorku which connects jobseekers with employers across Africa. Several startups, such as Obami and Shasha Iseminar, are geared towards making education more accessible for the masses.

Considering the potential power entrepreneurship has in shaping Africa, it is not surprising, then, that investments in African startups have increased. VC4Africa was founded in 2008 as an online community of venture capitalists, angels and entrepreneurs dedicated to building businesses in African countries. VC4Africa reported in 2015 that 104 investments in startups across Africa were listed in their platform, with a total amount of USD 27 million, which is more than double the prior year’s figures.

Yet, it would be premature to overstate that entrepreneurship will eradicate all of Africa’s problems. It is, however, reasonable to suggest that it will likely move the continent in a better direction socially and economically. Job opportunities are increasing in almost every African country due to the creation of new businesses. Approximately six jobs are created for every new venture, and that number is expected to quadruple resulting in about 4176 new jobs according to a report released by VC4Africa 2015.

The belief that investing in Africa is risky, however, stands in the way for obtaining yet more funding. The costs of service in Africa as well as the cost of electricity and Internet connection are extraordinarily high according to Global Risk Insights. There is a fear that these high costs will eat away at revenue for foreign companies.

Additionally, the majority of African entrepreneurs lack the formal education needed to succeed in the business world. Education is still inaccessible to many citizens in various parts of the continent and the quality of education is still subordinate to that of many non-African countries. The budget allocated to education of a single country such as France, Germany, Italy or the United Kingdom outweighs education spending across the entire sub-Saharan African region, according to a new report from the UNESCO Institute for Statistics (UIS). This naturally begs the question: is it realistic to expect people with an inadequate education to start a business and be successful? Shortage of local talent can be seen as a red flag, especially for investors and executives of foreign corporations.

But despite these systematic problems that might deter foreign investment, this generation of African entrepreneurs is attempting to find big solutions to big problems. Their positive impact is evident today as it pertains to the continent’s growth and development, and it is still possible that Africa will look drastically different years from now with its growing crop of entrepreneurs and investors.

Can you remember those miserable days before Venmo came around? The hassle and confusion that inevitably arose every time you and your friends split a cab and everyone had to figure out who owed whom? For millions of Americans (Venmo will not disclose exactly how many users they have), Venmo has become such an integral part of daily life.

Started in 2009 by two University of Pennsylvania students, Andrew Kortina and Iqram Magdon-Ismail, Venmo is now a must-have app that allows people to seamlessly and effortlessly pay back a friend for a drink, a meal or a wild night out. A bank account, debit card or a credit card is linked to your account, which you can then use to transfer money to anyone- even those without a Venmo account. At the tap of a finger, one can also request money, which can then be rolled back into a bank account.

Venmo, which was acquired by PayPal in 2013, is currently one of the fastest growing apps in the world by dollar volume. In the third quarter of 2015, it processed $2.1 billion dollars, triple the amount in the same quarter in 2014 and up from $1.6 billion in the previous quarter. In a bid to turn Venmo into a moneymaker, PayPal announced in its third quarter report this October, that it would allow merchants to accept payments through the service, charging merchants the same 2.9% transactions fees that Venmo’s sister, PayPal, charges.

Venmo is just one of many financial technology companies – now fashionably referred to as fin-tech companies – that have revolutionized the way money changes hands. Long seen as a highly regulated field dominated by a few corporate giants, finance is now riding an entrepreneurial wave. Whether it be payment, peer-to-peer lending, crowd funding or wealth management, a new generation of startups is harnessing software and the power of the internet to take aim at the heart of the industry and a pot of revenue Goldman Sachs estimates at $4.7 trillion. Although the fintech industry remains small and many of the most talked about startups – including Venmo- have yet to turn a profit, pundits predict that Fintech will reshape finance in profound ways.

The Economist suggests that fintech disruptors, unburdened by the same amount of regulation, legacy IT systems and branch networks, will be able to cut costs and improve the quality of financial services. Lending Club, a peer-to-peer lending company headquartered in San Francisco, has expenses of about two percent of its loan balance versus an average five to seven percent for conventional lenders. IPOed in 2014, Lending Club operates as an online platform that allows borrowers to obtain loans and investors to purchase notes backed by the payment made on the loans. With lower operating costs for small loans, new peer-to-peer lending companies such as Lending Club can therefore offer better deals to borrowers and lenders.

Similarly, the Economist reports, other startups are improving the quality of financial services. Funding Circle, operating around the clock, receives half of its loan applications outside of normal business hours, improving the ease with which small businesses are granted loans. TransferWise, on its side, allow people to transfer money across borders at a fraction of the cost banks would levy for the same service.

Until recently, lending to individuals or small businesses was typically based on a single credit score and a meeting between a banker and a client. The cost inherent to this traditional form of relationship lending encouraged lenders to chase only big borrowers at the expense of small borrowers. With the advent of new data-driven and digitalized lending platforms, however, young borrowers who were previously on the fringes of the banking system are for the first time being given easier access to funding.

Prosper, another lending company, relies on over 400 data points including factors such as the applications relationship with suppliers, shipping companies and credit card processors, e-commerce activity and cell phone records to underwrite loans. Similarly, OnDeck has loaned over 2 billion to small businesses across 700 industries in the United States and Canada evaluating creditworthiness through a proprietary method that allows them swiftly process loans within a day. Affirm, Kabbage and Earnest are just a few more of a multiple of startups that have come up with clever new ways to compile vast sources of data to come up with more accurate assessment of borrowers riskiness.

The data these startups rely on, Steve Lohr from the New York Times reports, go substantially beyond credit history, and include subtle predictions about the borrowers’ behavior gleaned from a vast array of online and offline sources. It is not farfetched, Lohr believes, that bankers of the future may forego observing traditional metrics, and look to see if potential customers use only capital letters when filling out forms or the amount of time they spend online reading terms and conditions (metadata analysis has determined that these attributes are correlated with the likelihood of default) What does this mean for you? Don’t upload Facebook posts of you and your friends doing shots – it might not be good for your credit score.

Finally, automated investment services, frequently called “robo advisors” have been revolutionizing the field of wealth management. Built on the premise that many of the activities performed by a Registered Investment Advisor can be performed by software, these new technology backed advisors have drastically cut costs by providing automated, algorithm based portfolio management advice without the use of human financial planners. By eliminating the middlemen and cutting costs, robo advisors have widened the reach of the industry – traditionally reserved for the wealthy – making it for the first time accessible to anyone with an Internet connection.

Over the past few years, these robo advisors have been enjoying astronomical growth. Betterment and Wealthfront, both of which build and manage personalized investment portfolios with customized asset allocations based on an individuals risk score and account tax status, have grown to manage 3 and 2 billion respectively in just three years.

It goes without saying, that traditional wealth management divisions at many of the big banks are watching the emergence of the robo advisors with a heavy dose of unease. In the best case scenario for current wealth managers, robo advisors will merely put downward pressure on management fees, while in the worst scenario, robo advisors will make traditional wealth managers obsolete.

Financial advisors are finding it progressively harder to effectively market themselves, particularly to younger generations. Millenials, soon to become the largest client group, have a particularly strong distrust towards financial institutions, Deloitte noted in a recent report. As such, Deloitte predicts money management is going to be disrupted and reinvented in significant ways. Betterment, Wealthfront and tech driven personal finance startups, who have enjoyed particular success among younger generations, stand to benefit tremendously.

“Without a doubt the era of fintech is upon us” Dominic Broom, Head of Treasury Services at BNY Mellon wrote, in a 2015 report. Indeed, global fintech financing has dramatically increased from just 3 billion in 2013 to 20 billion in 2015. While there has been a lot of debate about the tech bubble bursting in 2016, many pundits see bright prospects for the fintech subsector. Dartmouth grads and MBAs who dream of a lucrative future at the traditional behemoths like Goldman or JP Morgan might want to have a plan B. Forty years ago, working at IBM and Xerox were dream jobs too.