What Is a Unicorn Company and Can You Invest In One?

PeopleImages / Getty Images/iStockphoto

PeopleImages / Getty Images/iStockphoto

If you’re a fledgling investor, you may have come across the term “unicorn” and wondered what a mythical creature has to do with finance. Venture capital investor Aileen Lee first used the term in 2013 to describe privately-owned startup companies with valuations of over $1 billion. When researching such startups, she discovered that less than 1% had such valuations; the degree of rarity led her the term.

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Here’s more about unicorn companies and whether you can invest in one.

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Can You Invest In a Unicorn Company?

Before the company debuts with its initial public offering (IPO), only institutional investors can invest. Institutional investors are legal entities, including organizations like venture capital funds, banks, credit unions, insurance companies and real estate investment trusts. Individual investors are able to invest only after the company goes public. It’s a good idea for individual investors to keep track of these startups that haven’t yet debuted on the market so they’ll be prepared should they go public and the opportunity arises.

As startups, the valuations of these companies are based primarily on their perceived growth potential. Investors don’t put much consideration into their established performance over their expected performance, as they have, at best, a short track record that doesn’t provide enough data to make an informed valuation. Instead, investors look at competitor performance and other elements to predict future performance. However, the fact that these companies tend to be novel only makes it more difficult to make a comparison.

What Are Some Examples of Unicorn Companies?

Two of the most lucrative unicorn companies are Uber and Airbnb, both of which dealt with established concepts — public transportation and property rental — in new ways. People were obviously used to hailing taxis, but the idea of requesting transportation from your phone only goes as far back as the smartphone itself. Airbnb found success by offering an affordable, user-friendly alternative for people who weren’t happy with hotel rooms. The two companies’ initial performance going public starkly contrasted; Uber’s share price dropped, whereas Airbnb’s more than doubled.

Should You Invest in a Unicorn Company?

The question of whether or not you should invest in a unicorn company when it comes to market ultimately comes down to how comfortable you are with their performance from start-up to public offering. Some of these investments are still highly speculative in nature. Prospective investors should follow their inclination toward risk versus reward.

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This article originally appeared on GOBankingRates.com: What Is a Unicorn Company and Can You Invest In One?

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