What Corporate Innovation Teams Need to Know about the New Breed of Unicorns

In tech investing circles, unicorns—defined as a private company valued at $1 billion or more—are no longer a rare breed.

Private equity researcher CB Insights says there are 170 operating in markets around the globe. As a group, investors value them at $620 billion.

Uber alone accounts for $68 billion of that total. Of the rest of the top five, China's Xiaomi ($46 billion) and Didi Chuxing ($36 billion) rank second and third, followed by Airbnb ($30 billion) and Palantir Technologies ($20 billion). Corporate venturers have played a role in backing four of them.

Corporate Venturing's Role in Birthing Unicorns

No firm has had more success than Google Ventures, which led Uber's $258 million C round in 2013 and then put in more money in 2014's D round. At the time, the market valued Uber at just $17 billion.

Digital Sky and Qualcomm have backed Xiaomi while Softbank has put money into Didi Chuxing. In-Q-Tel, the unofficial investing arm of the U.S. Central Intelligence Agency, has money in Palantir.

Should these success stories have corporate venturers hunting for new unicorns? If so, how likely are we to see more of them in the coming years? Let's return to CB Insights' data for the answers.

An End to the Baby Unicorn Boom?

So far, 2016 hasn't been so much about birthing new unicorns as it has been about fattening up the existing herd.

Seven VC-backed companies reached the $1 billion plateau in the second quarter, up from five the prior quarter but down from 24 in last year's Q2. Valuations aren't climbing as much with investors focusing capital on bigger, better established bets.

According to the quarterly Venture Pulse Report from KPMG and CB Insights, investors had struck just 3,894 deals through the second quarter. While that's less than half the number of VC-led investments made in 2015 or 2014 (and about half the number made in 2013), the dollar flow remains as strong as ever.

Investors have put an estimated $53.9 billion into financings, or roughly $13.8 million per deal. Last year investors bet an average of $14.7 million per deal, and that ended up being a record year for birthing unicorns. Corporate venturers and other deep-pocketed financiers are putting money to work shoring up established unicorns such as Uber.

Where Unicorns Come From: Everywhere

You might even say that corporate venturers are responsible for the rise of unicorns.

"Corporate [venturers] are generally bigger and so need things to move the needle, which in turn usually means larger, more valuable private companies—whether unicorn or not," says James Mawson, founder of Global Corporate Venturing, a publication that tracks how corporates are investing around the world.

And yet it's interesting to see when and how corporates tend to enter the mix. Looking just at the top five unicorns, Google got into Uber at a $3.5 billion valuation. Qualcomm got into Xiaomi right as it was joining the unicorn club, at a $1 billion valuation.

Think of it as a cycle. Corporates pile into proven ideas, driving up valuations to or past unicorn levels, which in turn drives more investment and higher valuations. Everyone wins, right up until the point there's a down round, when startups take new money from investors at a valuation lower than in prior rounds of funding.

Hunting the Next Herd of Unicorns: What Corporate Venturers Need to Know

Down rounds happen more than you might think, even to the market's unicorns. CB Insights says that both Flipkart and Xiaomi are rumored to have suffered down rounds recently while Square and Box executed IPOs at lower valuations than they'd achieved as private, VC-backed enterprises. And while there have been a rush of billion-dollar buyouts, exactly none of the startups acquired recently was worth $1 billion before an offer came in.

Unicorns aren't faster to exit, and thanks to down rounds, they don't always command a premium when hunting for new financing or organizing an IPO. So how should corporates respond? By diversifying.

Offer startups debt financing or growth capital. Or better yet, join traditional venture capitalists in backing a handful of seed-stage startups. The risk of total loss is slightly higher than betting on a late-stage unicorn but the potential return could be worth the risk. The key, Mawson says, is to know if your team is"comfortable with the potential consequences" of being wrong—because they will be.

Wrong bets are part of the business of funding innovation. Try, fail, try again, fail again, and again, and again, and again before eventually succeeding. Headline-making unicorns don't change the odds, but they do make the game more interesting.