Unicorn cover crop
Illustration by Jeremy Enecio for Fortune

Don’t worry unicorns, public market validation is a mirage

May 28, 2015

"The valuations are just made up."

This is a line I've heard (and read) over and over when it comes to the high prices that venture capitalists are paying to invest in tech startups, including the so-called unicorns. It's said as a contrast to how companies are valued by the public markets, which is broadly-believed to be a better arbiter due to its relative size, dynamism and transparency.

And, to be sure, precious few of these unicorns have chosen to go public. But I'm not so sure that the public markets deserve their reputation as smarter than the private markets.

Since the beginning of last year, Pitchbook data shows there have been 17 U.S. IPOs of VC-backed tech companies that were valued at $1 billion or more either at the start or close of their first day of trading (excluding six such biotech companies). Of those, nine closed trading yesterday with stock prices lower than where their stock price opened on their first day of trading. Another one -- New Relic (newr) -- closed trading yesterday lower than where it closed on its first day of trading.

Or, put another way, the public markets overvalued more than half of the big VC-backed tech companies it "received" over the past 17 months. This isn't about VC firms driving up prices to win deals. It's about sophisticated public market investors being wrong, despite all of their supposed advantages.

Moreover, this isn't just about overvaluing. The public markets can undervalue too. The aggregate market cap of those 17 companies was 65.23% higher yesterday than it was at the end of the cohort's first day of trading (some of which, admittedly, is due to increases in the number of outstanding shares).

I'm not trying to argue that private market valuation creep isn't an important issue, or that most of the unicorns will keep their horns. Instead, I'm simply saying that we shouldn't use the public markets as a canny cudgel to reject tech startup valuations, since they haven't proven any better at predicting future value.

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