Since 2019, the number of billion-dollar, venture-backed companies in the world has grown from 223 to 704 with a combined value of $2.3 trillion. Utah is home to 13 unicorns with a total value of $33.2 billion, up from just two unicorns in 2019. 

Becoming a unicorn has been the ideal for many tech startups: it feeds the ego, leads to more publicity, breeds confidence and ultimately works to attract top-notch talent and customers. “It sort of certifies the company [and says], ‘We have arrived,’” says Jay Ritter, a University of Florida finance professor who tracks data on IPOs and growth companies.

Yet new research and a look at historical IPOs suggest that many of those companies may not be worth as much as they say. In fact, taking advantage of the way that “headline” valuations are calculated for these private companies, they may drastically overstate their value just to land the prestigious title of “unicorn.” 

On average, the headline valuation number overstates the value by more than 50 percent, according to research from several academic studies, including a new paper by Minmo Gahng, a University of Florida Ph.D. student who will join Cornell University as an assistant professor of finance. Add a frozen market for initial public markets, and things get harder to swallow.

“If a company was saying they achieved unicorn status, they were actually worth about $700 million,” Ritter says. “Now they’re faced with going public at a $500 million valuation and this is a real disappointment.”

More IPOs were seen in 2021 than in any year since 2000, but the market dramatically cooled last year—and remains cold. Even if the IPO market does warm up, unicorns haven’t fared so strongly in the public markets. Only 200 companies in the last decade have IPO’d for over $1 billion, according to data by Battery Ventures. And among those that did go public between 2008 and 2021, only 28 percent of them have been profitable, according to Statistia. 

Institutional investors may have been willing to pay increased valuations between 2018 and 2021, but they are now scrutinizing those private valuations. “When a company goes public, sophisticated institutional investors are going to realize that just because you said you were a unicorn doesn’t mean the true value is really $1 billion or more,” Ritter says.

Jesse Randall, founder and CEO of Boulder-based Sweater VC, chalks the huge number of unicorns to bigger VC funds. Last year alone, the average fund size grew by 38 percent, according to PitchBook. Last fall, for instance, EQT Ventures closed its third fund on roughly $1.1 billion, a 66.7 percent increase in size from its predecessor. 

“The funny thing is that venture capital worked really well for the first 40 years of existence,” Randall wrote in a popular LinkedIn post. “The math was different because the VC funds were different. They were smaller.”

Randall, whose firm invests in actively managed portfolios of early-stage companies, suggests that the math of the VC fund drives the math of its investment criteria, which drives the math of the startup valuation, which drives the math of the funding path for the startup, which drives the long-term valuation—which, finally, drives the exit requirements. His LinkedIn post was viewed by more than 1,600 people and generated more than 180 comments.  

Valuations matter not only for investors but also for employees. Startup employees often receive wages lower than the market rate but also receive stock options—viewed as “lottery tickets”—by employees, writes Gahng, citing prior work in his paper. They might assume that a higher valuation signals higher compensation, but inflating those values actually lowers the expected value of employee stock options. Yet, startups “systematically stretch their valuations” to achieve $1 billion to attract those employees, he writes. 

How exactly do they do that? They offer investors in their most recent financing rounds something called convertible preferred stock, which is preferred stock that can convert to common stock and ensures those investors are paid back before common shareholders get anything in cases of bankruptcy, Ritter says.

But companies are also adding what Ritter calls “bells and whistles” to that stock, which includes put options, such as an IPO ratchet, anti-dilution provisions and other tools that either inflate the value of common stock or give the recent buyers extra shares to compensate them in cases of a down round—or cases in which new investment is accepted at lower valuations.

For example, a new round of investors might buy a company’s stock at $35 a share, but the next round price is only sold at $25 per share. Those previous investors are compensated by receiving additional shares to make them whole. These put options make their convertible preferred stock worth more than just traditional convertible preferred stock.

Common stock doesn’t have this, nor do employee stock options, but companies have been valuing common stock at the same price as the preferred stock. 

The headline valuation also fudges the value of authorized—yet not granted—options. For instance, a company has 10 million options outstanding and they have authorized another 2 million options. Instead of calculating the market value on the basis of 10 million options, they’re calculating on the basis of 12 million.

These authorized but unissued shares for future employee compensation, such as stock options in employee option pools, account for 11 percent of the headline valuations. In other words, an average startup with an exact $1 billion valuation would be valued at $890 million if it did not include these unissued shares in the valuation calculation, Gahng writes.

No one knows when authorized stock options will be granted, vested and exercised, “so treating newly authorized but not yet granted options as having the same value as already outstanding shares is hard to justify,” Gahng writes. Yet tech startups authorize 65 percent more shares for future employee compensation per dollar raised for financing rounds that lead them to achieve unicorn status, he says.

Enter the reset of 2022. Now that valuations have come back down to more justifiable levels, the unicorns must switch from a growth-at-all-costs mindset to one focused on fundamentals and profitability. 

If a company seeks new rounds of financing at lower valuations, it’s a hit to employee stock options. Not only is the company raising money at a lower valuation: the more money that’s raised, the more diluted the shares of common shareholders and employees. 

If unicorns don’t raise more money and instead attempt to preserve their cash and extend their runway, it can mean trimming costs and layoffs. More than 106,000 people have been laid off by U.S.-based tech companies in 2022 and 2023, Crunchbase reports. Hundreds of people lost their jobs at Utah unicorns, including Podium, Pluralsight, Venafi, Route, MX, Taxbit and Brex.

Part of that is just market dynamics, says Sid Krommenhoek, founder of Lehi-based Album VC. 

“It’s really easy right now for the news to crucify these tech companies, like, ‘Oh, they were valued at a billion and they’re laying off people,’” Kreommenhoek says. “The truth is that they hired a lot of people because the market supported it, and those that didn’t get to real profitability will be those that struggle.”

Plus, not all Utah unicorns are burning cash. Kyle Spackman, chief commercial officer at Sword Health—which hit a $2 billion valuation in 2021—says the digital physical therapy provider has growing revenue and 1,400 customers but isn’t profitable. The billions in the bank also means Sword Health won’t be raising new rounds at lower valuations or doing layoffs. In fact, the company may grow to 1,000 employees, up from the 700 it has today. 

All told, Sword Health isn’t in a rush to go public. 

“An IPO is another milestone and not the end in of itself,” Spackman says. “Our focus right now is building an enduring business.”

The concept is so rare, it just might be a new kind of unicorn.