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Every funding round comes due
The $2 billion round
Instacart raised its Series C at a $2 billion valuation from Kleiner Perkins and Mary Meeker, a tremendous investor. That was the market, and the company was trying to raise at as high a price as possible. It was one of many things that almost took Instacart down.
What capital costs
Kleiner has a cost of capital, meaning Instacart now owed it something like 25 to 30 percent a year, compounding. Instacart's president felt that every time he took someone's money he owed them their cost of capital.
Luckily, Kleiner did well on Instacart. People still don't think that way: the tax of a high price is real, and the bill comes due at some point.
Why must a high valuation grow even larger?
A venture investor who buys in at a high price needs the company to be worth much more later to earn the returns the fund promised. At a $2 billion valuation, a tenfold return means a company worth about $20 billion at exit. Venture funds aim well above stock-market returns because they hold risky stakes that cannot be sold easily. A 2012 report by the Kauffman Foundation reviewed its venture fund investments and found that most had not beaten public stock markets after fees.
Why do a few investments carry the whole fund?
Venture returns follow a power law, in which a small number of investments return most of a fund's money. Most startups return little or nothing, so the winners have to cover the losses. Peter Thiel described this pattern in his 2014 book Zero to One. He wrote that the best investment in a successful fund returns more than all the others combined.
How did billion-dollar valuations become common?
In November 2013, investor Aileen Lee of Cowboy Ventures coined the term unicorn for privately held startups valued at $1 billion or more. Her count at the time was 39 US software companies founded since 2003. Years of low interest rates after the 2008 financial crisis had sent investors looking for higher returns in private companies. The number of such companies grew into the hundreds worldwide by the late 2010s.
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