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.
Alistair Marsden
Director
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.
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