Term Sheet — Monday, November 2

It’s a bit of an open secret in Silicon Valley that none of the so-called unicorn startups, valued at $1 billion and up, are actually worth their $1 billion (and up) valuations. They will be, but they're not right now.

That sounds crazy to an outsider, but Term Sheet readers know it's how venture capital investing works. High-growth, high-risk tech startups are given astronomical valuations based entirely on the promise of future growth. Venture capital is a high-risk asset class, so it's supposed to be a stretch.

Snapchat’s venture investors say it’s worth $16 billion. But if the company went public today, with a target of $50 million in annual revenue and zero profits, Wall Street traders wouldn’t be so generous.

The company's investors expect it to grow fast enough that eventually, Wall Street will believe it is worth $20 billion, or $30 billion (or $32 billion, if anyone in the latest round plans to double their money).

But not every unicorn is going to live up to its potential. Investors have warned of "dead unicorns" and "unicorpses" all year, and we're already seeing the cracks: commentators say $10 billion Dropbox is increasingly looking like a “feature not a service,” $9 billion Theranos is battling a wave of questions about its technology, $1 billion Evernote has experienced executive turnover as it prepares to go public, $800 million Flipboard lost its top executives after several acquisition talks fell through, according to Bloomberg.

The closer we examine the country's most valuable startups, the more flaws we see. The more flaws we see, the more we wonder whether any of the most successful startups aren't masking ugly dysfunction just beneath the surface.

The number one reason venture capitalists say the current tech boom is nothing like the dotcom bubble of the late ‘90s is that today's highly valued startups are real businesses. The money-burning dotcoms from the last go-around went public with little or no revenue, so when it all collapsed, they went down to zero. But this wave of startups, they have revenue. They are building real businesses, disrupting hotels, taxis, housecleaning, and data storage. If it all collapses, they won't go down to zero, because "there's a there there."

Rather, the worst case scenario is that the unicorns, which have created $500 billion in value to date, don't live up to their valuations. All of them have to exit at some point; that's how venture capital works. For most, that means an IPO. Only a select handful of acquirers can afford to spend $1 billion or $10 billion on a startup acquisition, and odds are Google, Facebook, Amazon and Apple already had the chance to buy the most attractive startups before they got this expensive.

But the IPO market is just as challenging as the M&A market. Fortune’s Steve Gandel recently crunched the numbers: If all 90 of the U.S.-based unicorns to went public, selling a standard 35% of their shares at a 20% premium to their last valuation, IPO investors would have to buy $131 billion worth of newly issued shares. Even spread over several years, that’s more than a stretch. Last year, only 22 tech companies went public, raising just $7.6 billion. The market for all IPOs this year so far is only $35 billion, down from the $56 billion average over the last 20 years.

When unicorns go public at lower valuations than their last round of funding, a few things happen. For one, "rachets" and other investor guarantees kick in. Many startups pay for their high valuations with lopsided terms that favor the latest investors. Some guarantee that the late stage investors get paid out before any other shareholders. Others issue more shares to late stage investors in the event of a lower valuation. In most cases, this hurts employees, founders and early stage investors the most. (Some early stage investors don’t know their shares were diluted by a rachet until after the IPO.)

Second, public market investors get skittish. The narrative of a high-growth rocketship becomes a story of a battered, challenged, question mark. CEOs lose the benefit of the doubt. Top employees leave. Competitors move in.

If this begins to happen more frequently than not, it will become difficult for any startup unicorn to go public.

When we put a unicorn on the cover of Fortune last January, I thought it might signal a peak. I was wrong – funding, especially at the late stage, only accelerated. For visual proof, check out this CB Insights timeline.

As we enter the next phase of "The Age of Unicorns," many highly valued companies will struggle to live up to their valuations, meeting harsh scrutiny from the press, regulators, and future public market investors. Becoming a unicorn, it turns out, was the easy part.

While Dan is out, send deal news and tips here, and follow along on Twitter here.

THE BIG DEAL

• CVC Capital Partners, Cerberus Capital Management, and JC Flowers, placed separate bids for the French banking unit of General Electric, according to Reuters. The deal for the unit, which has around $6.6 billion in assets, is expected to wrap up in the coming weeks. Read more.

VENTURE CAPITAL DEALS

• AppDynamics, a San Francisco-based business application performance management company, has raised $83.3 million in a funding round with room to go up to $150 million, according to an SEC filing. www.appdynamics.com/

• ClearSky Data, a Boston-based provider of storage networks for customer data, has raised $27 million in Series B funding from Akamai Technologies. Read more.

• Personal Genome Diagnostics, a Baltimore-based provider of advanced cancer genome testing products and services, raised $21.4 million in a Series A funding round led by New Enterprise Associates with participation from Windham Venture Partners and Nanjing Kaiyuan Growth Capital Investments. www.personalgenome.com/

• Confer, a Boston-based cybersecurity company, raised $17 million in a Series B funding round led by Foundation Capital, with participation from existing investors Matrix Partners and North Bridge Venture Partners. www.confer.net/

• Nestpick, a Berlin-based movie rental startup, has raised $11 million in Series A funding from Mangrove Capital Partners, Enern and Rocket Internet. www.nestpick.com/

• Gobble, a Palo Alto-based meal kit startup, has closed a $10.75 million round of Series A funding led by Trinity Ventures. www.gobble.com/

• Qraved, a Jakarta-based startup focused on restaurant reservations and food-related media, raised $8 million in Series B funding led by Richmond Global Ventures and Gobi Partners with participation from new investor GWC and existing backers Convergence Ventures, 500 Startups, Toivo Annus, and M&Y Partners Read more.

• Tiny Owl, a Bengalaru-based food ordering software startup, has raised $7.67 million from Matrix Partners and Sequoia Capital. www.tinyowl.com/

• Vinaya, a UK startup focused on smart devices, has raised $3 million in funding led by Eileen Burbidge of Passion Capital, with participation from Playfair Capital and angel investors. www.vinaya.com/

• Calculus Capital invested £2.5m in IPV, Cambridge, UK-based provider of multi-media content management systems. www.ipv.com/

• 3nder, the London-based “Tinder for threesomes,” has raised $500,000 in seed funding from an (unsurprisingly) undisclosed group of angel investors. Read more.

• Sochat, the San Francisco-based maker of a messaging app, raised $2 million in Series Seed funding led by Eniac Ventures, with participation from New Enterprise Associates, Greylock Partners, Slow Ventures, Foundation Capital, Betaworks, and Maiden Lane. www.sochat.com

PRIVATE EQUITY DEALS

• MedAssets (NASDAQ:MDAS), an Atlanta-based healthcare performance company, has agreed to be acquired by Pamplona Capital Management for $31.35 per share in cash. The purchase price represents a 44.5% premium to the 30 trading day volume weighted average price of MedAssets common stock and an enterprise value of approximately $2.7 billion. www.medassets.com/

• Norwest Equity Partners has acquired Marco, a St. Cloud, Minn.-based provider of business technology solutions. Financial terms were not disclosed. www.marconet.com/

• Chopt Creative Salad Company, a fast casual salad restaurant chain, has sold a stake in itself to private equity firm Catterton, alongside The Hain Celestial Group, Inc. (Nasdaq: HAIN). Terms of the transaction were not disclosed. www.choptsalad.com

• Area Wide Protective, a portfolio company of The Riverside Company, has acquired Traffic Specialities, a Stone Mountain, Ga.-based temporary traffic management solutions company, for an undisclosed amount. riversidecompany.com/

• Contagious Gaming, a London-based provider of gaming software for lotteries and gaming operators, has acquired Digitote, a Vancouver-based provider of sports betting and horse racing technology, for C$7.1 million. www.contagiousgaming.com/

• The SPOT Experience, a New York-based provider of pet care services, has taken an undisclosed investment from Drayton Park Capital. The company has also taken on investment from Mistral Equity Partners. www.thespotexperience.com/

IPOs

• EMC and Dell plan an IPO of Pivotal, the software company owned by EMC through a joint venture with GE, according to Re/code. Read more.

EXITS

• OptiNose, a specialty biopharmaceutical company backed by Avista Capital Partners, the Entrepreneurs’ Fund and WFD Ventures, is for sale, according to Bloomberg. The deal could be worth as much as $1.5 billion. Read more.

• Thoma Bravo has completed the sale of Sirius Computer Solutions, a San Antonio-based IT solutions integrator, to Kelso & Company. The deal terms were not disclosed. www.mysiriuszone.com/

• Artisan Mobile, a Philadelphia-based provider of A/B testing software for mobile apps, has sold to Tune, a Seattle-based mobile marketing company, citing being “too early” as the reason it came up short. Artisan Mobile was backed by FirstMark Capital. Read more.

• Trend West, a Hyderabad-based online venture of Tata Trent, has acquired a segment of Eat.Shop.Love, a venture-backed ecommerce outfit based in Bengalaru, according to the Economic Times. Read more.

• Compass Automotive Group, a Franklin, Ind.-based maker of automotive components, has sold to the Shipston Group for an undisclosed amount. Compass was backed by Monomoy Capital Partners. www.compassautogroup.com/

OTHER DEALS

• TreeHouse Foods (NYSE: THS) has signed a definitive agreement to acquire ConAgra Foods’ private brands operations, for $2.7 billion. The combined entity will have nearly $7 billion in annual revenue. www.treehousefoods.com/

• Quality Systems (NASDAQ: QSII), basd in Irvine, Calif., has agreed to acquire HealthFusion Holdings, a San Diego, Calif.-based developer of cloud computing software for physicians, hospitals and medical billing services for $165 million plus potential additional contingent consideration of up to $25 million. www.qsii.com/

• Securus Technologies, a Dallas, Texas-based provider of technology for public safety, announced today that it has acquired Guarded Exchange, a Jefferson City, Missouri-based corrections industry tech company for an undisclosed amount. opguardedexchange.com/

• Publicis Healthcare Communications Group, a subsidiary of Publicis Groupe, has agreed to acquire the commercial services business of PDI, a healthcare commercialization company based in New Jersey and and Pennsylvania for $25.5 to $32.5 million in cash not including earn-outs. www.pdi-inc.com/

• Shire, a Dublin-based biotechnology company, has acquired Dyax Corp. (NASDAQ: DYAX), a Massachusetts-based biotechnology company focused on the development of plasma kallikrein inhibitors for the treatment of hereditary angioedema, a rare genetic disease, for $37.30 in cash per share, or approximately $5.9 billion. www.dyax.com/

FIRMS & FUNDS

• CommonAngels Ventures, a Cambridge, Mass-based early stage investment firm, has changed its name to Converge Venture Partners to reflect the change in its investment model to a fund. www.convergevp.com/

• Pitango Venture Capital has held a first close on Pitango Growth Fund, which has a $250 million target. The firm also invests out of its early stage fund, Pitango 6. www.pitango.com/

• CalPERS is reportedly closing the sale of a $1 billion portfolio of private equity interests as it moves to trim its holdings in the category, according to peHUB. Read more.

MOVING IN, UP, ON & OUT

• Jennifer Holmstrom has joined Highland Capital Partners as a Talent Partner, the firm’s second. Holmstrom previously worked on Facebook’s executive search team. www.hcp.com/

• Pascal Cagni, Founder of C4 Ventures and former vice president of Apple Europe, will join the Pitango Venture Capital. www.pitango.com/

• Jordan Hansell, former CEO of NetJets, has joined Rockbridge Holdings as President. www.rockbridgecapital.com/

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