Chimeras & Unicorns

The following is adapted from The Rise of the Chimera: Eating Unicorns for Lunch, by J. Skyler Fernandes. 

This is about understanding market size dynamics for companies worth US$1+ billion (unicorns) to US$1+ trillion (chimeras).  It is 2021, and human civilisation has now created a number of companies worth over US$1+ trillion, including Amazon, Alphabet, Apple, Microsoft, Facebook, and Saudi Aramco.  All are digital first companies, with the exception of Saudi Aramco.  These US$1+ trillion companies have grown far beyond the US$1+ billion unicorn valuation status in their size and capabilities.  VU Venture Partners fund has coined a term for companies worth US$1+ trillion; they are known as chimeras, an organism with a mixture of DNA from different species, often shown in Greek mythology as a lion, a goat, and snake.  These chimeras are 1,000 times larger than a baby unicorn starting at US$1+ billion valuation, and they have grown to be the hungriest and mightiest acquirers of unicorns. 

The future of human civilisation has only two options: Humans will cease to exist, or more and larger US$1+ trillion companies will be created, and hopefully that is not because of inflation.  As companies evolve their capability to go after new and larger market opportunities continues to increase.  Additionally, overtime the maximum potential size of market opportunities continues to increase as the population of humans and enterprises, the number of customers, grows and the wealth of consumers and enterprises, the ability to pay, improves.  Breaking the US$1+ trillion valuation number has shown humanity that what seemed impossible is now possible.  It is a psychological marker.  It conveys the point that market size opportunities that are truly massive exist here and now, and even larger opportunities, which have yet to be created or scaled, will likely exist in the future.  But what will those massive market opportunities look like?  And what does a massive market size mean?  How big is the number on the far side of the market size opportunity spectrum for what is possible?  This article explores the full spectrum of what is possible for companies in terms of market size, revenue potential, and valuation. 

Humans have a difficult time thinking on large scales.  Everything larger than a number with 6 or 9 digits is just huge, and humans often do not have great perspectives for thinking on large scales.  A trillion is a 1 with 12 zeros after it.  It is quite a mind boggling number for most people to think about and this likely stems from the fact that it was not required to ponder at these scales in the past to perpetuate our own existence.  The range of market size opportunities for companies worth US$1+ billion to US$1+ trillion is massive, it is a 1,000 times difference in magnitude.  It is important for founders and investors to understand this difference in market size potential in order to identify the largest market opportunities to create and invest in.  The term “unicorn” is defined as a company with a valuation worth US$1+ billion and the number of unicorns has continued to grow each year.  According to CB Insights, “As of September 2021, there are more than 800 unicorns around the world.  Variants of unicorns include a decacorn for companies valued at over $10 billion, and a hectocorn for companies valued at over $100 billion.”  With the recent entrants of companies breaking the US$1+ trillion valuation, VU Venture Partners proposes a new category name for these type of companies: chimeras.  What is a chimera?  A chimera is a Greek mythical creature composed of multiple types of animals, often shown as a mixture of a lion, a goat, and a snake. 

In biological terms, a chimera is an organism containing a mixture of genetically different DNA and cell types.  If we were to google a “chimera” we would see images like these below.  Not nearly as cute and cuddly as a unicorn: Our investment team evaluated a large number of mythical creatures to find the best one that would match the characteristics of a company worth US$1+ trillion.  Some of the most common characteristics of chimeras include: they are platform plays, in that they sell more than one thing, across multiple industries, their customers include both consumers and enterprises, and they often have both physical and digital solutions. 

In fact, due to the physical limitations of the market size dynamics present on Earth today it is almost mathematically impossible to achieve the chimera US$1+ trillion valuation without having both consumers and enterprises as customers.  There are just not enough current humans or enterprises in existence today for a company to be worth US$1+ trillion if it were to just focus on one of these customer types.  Additionally, these chimeras have done a decent amount of acquisitions, and are some of the biggest acquirers of unicorns, absorbing them in different ways into their DNA.  Sometimes they acquire them for their talent and absorb them into their organisations, leaving little remains of the original acquired entity.  Other times, the businesses they acquire continue to operate as a separate yet connected entity.  For these reasons, the chimera is a strong metaphor for an entity that represents a platform made up of multiple things, and supports the characteristics required to achieve the scale of a US$1+ trillion valuation. 

Here is a list of the 6 current chimeras, as of Aug 2021, which have market capitalizations of US$1+ trillion, and with some additional statistics on enterprise value (market capitalisation + debt - cash), revenue, enterprise value / revenue (revenue valuation multiple), gross margin, and EBITDA margin:  

VU Venture Partners put together a list of the next top 100+ companies by market capitalisation to evaluate and better understand the nature of the largest public companies created by human civilization to date.  Below is the comparison of the statistics between the chimeras versus the next top 100 companies by market capitalisation. 

Tesla is currently the 7^th largest company by market capitalisation at ~US$700 billion+ and is the first non-chimera on the list of the next top 100 companies by market capitalisation.  Based on Tesla’s valuation, it is the next up to become a chimera, but if it crosses the US$1+ trillion line, it will be a chimera of a different breed.  Tesla’s revenue multiple (enterprise value / revenues) is significantly higher than the average current chimeras at 16x versus 7x, as it is earlier in its maturity, and has a lower gross margin profile at 22% versus 59%, given the nature of its business being more physical than digital.  Tesla’s EBITDA margin is also materially lower at 14% versus the average chimera is at ~41%, but that’s likely because it is reinvesting more into itself than the current chimeras do, with the exception of Amazon which also has EBITDA margins of around ~13%.  Amazon has a strong track record of reinvesting in itself and has also proven that it has no shortage of ideas for how to become greater than itself. 

Berkshire Hathaway is currently the 8^th largest company by market capitalisation at ~US$645 billion, but has an enterprise value of US$1+ trillion, as it is more greatly impacted by the enterprise value calculation: market capitalisation + debt - cash. 

Considering enterprise value / revenue: Shopify is the biggest outlier at ~47x revenues.  The 6 next biggest are between ~20–24x revenues (NVIDIA, Prosus, Visa, Moderna, Mastercard, Adobe), followed by the 10 next biggest at ~11–19x revenues.  The vast majority, 80%+ of the top ~100 companies by market capitalisation, including the majority of the chimeras, have revenue multiples of ~1–10x, and within this range it is largely influenced by their quality of revenues: one time revenue vs. recurring revenues, revenue growth, and gross margin. 

It is important to understanding market size dynamics and future valuation potential.  As venture capitalists, we have the rare job of seeking out massive market opportunities at their earliest stages.  As a general rule of thumb, VCs look for market size opportunities of US$10+ billion, and this is in terms of TAM, the total addressable market, often generalised and often a global market number.  VU Venture Partners prefers US$10+ Billion SAM’s, the serviceable addressable market, over US$10B+ TAMs, as SAMs are often more well defined as the geographic target market focus and the core target customer demographic.  A startup will likely get acquired or IPO well before going after their TAM, so TAM is a less meaningful number to a venture fund.  TAM is also often an overstated number by founders in its relevance to the actual business opportunity they are working on.  SAMs are more grounded in the revenue potential of your true target customer market size and is a number that should be able to be easily approximated using a simple equation: number of potential customers that exist, now or in the future, times how much you make in revenue on average per customer per year. 

Here are two simple SAM examples: 

Renting bridesmaid dresses = ~2.5 million weddings a year in the U.S. x ~5 bridesmaids per wedding x $150 dress rental = $1.875+ Billion. 

Selling bed mattresses = ~132 million U.S. households x ~2.5 beds per house ×~$1,000 per mattress / replacing a mattress every ~8 years = $41.25+ Billion. 

These two SAMs are 22x different in size.  That is a big difference in terms of market size opportunity.  These SAMs represent how big either company can grow in terms of future revenues if they acquired 100% of the market.  If either company could only acquire 1% of their respective markets in ~5 years then they would get to US$18.75 million versus US$412.5 million in revenues. 

The simplistic reason why VCs target US$10+ Billion market size opportunities is because a ~1% market penetration is equivalent to ~US$100M+ in revenues.  If a company believed they could acquire 1% of the market by year 5, then this US$100M+ would be the SOM, the serviceable obtainable market.  The SOM is often shown as the revenue goal of the company at the time of exit via M&A or IPO. 

Using a ~1–10x revenue multiple, a conservative revenue multiple range for most companies including the majority of the chimeras and the next top 100 companies by market capitalisation, a company with US$100 million+ in annual revenues would be worth ~US$100 million to US$1 billion+ in enterprise value and would be the estimated exit value via M&A or IPO. 

A VC / PE investor investing in a company at a US$10 million valuation and the company exits at a US$100 million to US$1 billion+ valuation, would get a 10x-100x return prior to the dilution from future rounds of financing.  That is the simple mathematics of a venture capitalist and private equity investor.

One notable exception to the general rule of using a ~1–10x revenue multiple range is that fintech companies often trade at an average range of ~10–20x revenues.  However most one-time product sale companies trade at ~1–3x revenues, recurring revenue businesses trade at ~4–10x revenues, and within these ranges they are influenced heavily by the quality of the revenue in terms life-time value of the customer, revenue growth, and gross margin. 

A company usually requires multiple rounds of financing to grow before it achieves an exit via an M&A or IPO.  VCs can more conservatively predict the potential return multiple of a particular opportunity if they estimate each future round of financing will be ~20% in dilution, which includes the dilution from new investors and any increases to the employee equity option pool, known as ESOP, the employee stock ownership plan.

 

This is a general guide for estimating equity dilution for founders and investors: After 3 financing rounds of dilution at ~20% each, we will have ~50% of our initial ownership.  If we start with a ~10% ownership stake x 0.8 (the 1^st follow-on round with a ~20% dilution) x 0.8 (the 2^nd follow-on round with a ~20% dilution) x 0.8 (the 3^rd follow-on round with a ~20% dilution) = 5.12% ownership, which is ~50% of initial 10% ownership.  Therefore, a VCs initial 10–100x return potential will become a ~5–50x return potential after three additional rounds of financing at ~20% dilution each.

 

Early stage VCs target a 10x+ return on each investment, inclusive of dilution.  Companies only capable of growing up to an enterprise value of ~$100M are not ideal opportunities for VCs to invest in.  If a VC invests at a $10M valuation and the company exits at a $100M valuation then prior to the dilution from any future rounds of financing the investor would make a 10x return.  However most companies require multiple rounds of financing to significantly grow revenues.  If a company requires a second round of financing to grow then the 10x return potential becomes a 8x return potential (assuming ~20% in dilution), and if a company requires a third round of financing to grow then the 8x return becomes a 6.4x return potential (assuming ~20% in dilution), and if the company requires a fourth round of financing to grow then the 6.4x return becomes a 5.12x return potential.  This is a non-pro rata return, assuming we do not invest in the follow-on rounds, and do not maintain ownership.  If we did participate in the follow-on rounds to increase or maintain our ownership amount then the return would still be <10x, as we would have invested additional capital at a valuation likely higher than initial US$10 million valuation, bringing down our average return multiple per dollar invested. 

Remember, as an alternative option, investors can always invest in real estate for significantly less risk and get a consistent 2–3x return every 5–7 years.  So for a VC to make an investment a company needs to be capable of returning 10x+, inclusive of dilution, to be worth the high risk of investing in an early stage company, and there needs to be a large enough market size opportunity to make a 10x+ return possible.  So what does it take to create a company worth US$100+ million to US$1+ trillion? 

Below we built three matrixes to show the difference in the scale of market size opportunities for companies to be worth US$100+ million, a horse, versus US$1+billion, a unicorn, versus US$1+ trillion, a chimera: 

Matrix 1 - Range of Revenues: Enterprise Value versus Revenue Multiple 

Matrix 2 - Range of Revenues: Market Size versus Market Penetration 

Matrix 3 - Range of Customers: Revenues versus Average Revenue per Customer Per Year

Matrix 1 - Range of Revenues: Enterprise Value versus Revenue Multiple 

For a company to have an enterprise value worth US$1 billion, a unicorn, using a 1–10x revenue multiple, it would need to be doing US$100 million in revenue with a 10x revenue multiple, or be doing US$1 billion in revenues with a 1x revenue multiple, and everything in between – for example, US$200 million in revenues using a 5x revenue multiple. 

For a company to have an enterprise value worth US$1 trillion, a chimera, using a 1–10x revenue multiple, it would need to be doing US$100 billion in revenues with a 10x revenue multiple, or be doing US$1 trillion revenues with a 1x revenue multiple, and everything in between – for example, $200B in revenues using a 5x revenue multiple).  The magnitude difference between a company worth US$1 billion versus US$1 trillion is 1,000x.  That is huge.  As a point of reference, the smallest company of the next top 100 companies by market capitalisation, after the chimeras has an enterprise value of US$122 billion. 

An acquisition enterprise value of US$100 million to US$1 billion is roughly 0.1–1% of the enterprise value of a US$100 billion company.  If our company is a chimera or one of these next top 100 largest companies by market capitalisation, then acquiring a company for US$100 million to US$1 billion is more like eating an appetizer than an entrée at ~1% or less of total enterprise value.  While exiting at US$100 million to US$1 billion valuation can be great for founders and investors, exiting at US$1 billion to US$10 billion valuation is even better.  If investing out of a US$100 million venture capital fund and we have a 10% ownership stake in a company that exits at US$1+ billion, then we have returned the entire fund.  If the company had exited at US$10 billion+, we would have 10x of our fund from just one company in the portfolio. 

A good rule of thumb for VC investors is that each portfolio company should have the potential of returning 25%-100% of the entire fund on a fully diluted pro-rata basis.  This way, only 1 to 4 exits are needed to return 1x the fund, and the rest of the portfolio companies can then return greater than a 1x fund.  Companies capable of US$100 billion or more in revenues are on an entirely different scale in terms of the size of the market opportunity they are addressing, and with a 1–10x revenue multiple can be worth US$100+ billion to US$1+ trillion.  The smallest of the current chimeras in terms of revenues is Facebook with ~US$104 billion in revenue and trading at a ~9x revenue multiple to get to its ~US$1+ trillion dollar valuation. 

Matrix 2 - Range of Revenues: Market Size versus Market Penetration % 

If a company executes well it may be able to achieve a ~1% market penetration of its target market, and if it really hits it out of the park it can get an even larger market penetration. Remember that even a ~5% market penetration means a company has acquired 1 in 20 customers in its target market, which starts sounding quite high.  So often it takes thinking like a monopolist to even acquire ~1% of a large market opportunity.  VCs often look for companies with target market sizes of US$10+ billion, where a ~1% market penetration equals US$100+ million in revenues.  It is a useful initial threshold to keep in mind. 

As a point of reference, at VU Venture Partners, most of the portfolio companies are going after market size opportunities that are between US$10 billion to US$100 billion.  They require the investment team to present a simple math equation during their investment committee to understand the logic behind the market size opportunity.  The simple math equation is: Market Size = the # of potential customers (now and in the future) x the average revenue customer per year = US$10+ billion.  If a company’s market size is less than US$10 billion, then the investment team needs to explain why they  believe it is possible to get significantly more than a 1% market penetration to still achieve US$100+ million in revenues at the time of exit. 

Founders need to be able to show how this simple math works for their company and supports the target market size they include in their pitch deck.  They should not reference a general research report that says the market size is $XX+ Billion, because it is highly likely that that number is not based on their company’s number of potential customers multiplied by their company’s revenue per customer per year.

 

Interesting factoid: The largest known market size on Earth is currently real estate at ~US$280+ trillion.  The future may change this, as the digital world could create assets worth the same or more than all physical real estate assets combined.  A market size of ~US$280+ trillion makes the initial US$10+ billion threshold that VCs look for seem like peanuts.  The magnitude difference between a US$10 billion market size and a US$1 trillion market size is a 100x, and a US$100 trillion market size, ~1/3 of real estate’s US$280+ trillion, is a 10,000x+ difference. 

Matrix 3 - Range of Customers: Revenues versus Average Revenue per Customer per Year 

Mathematically, it is very difficult to achieve an enterprise value of US$100 billion to US$1 trillion+ without addressing both consumers and enterprises as customers, as there is a finite number of humans and companies that exist on Earth that can become customers of a company.  The population on Earth in 2021 is currently ~7.9 billion, and estimated to grow to 10.9 billion by 2100 over the next ~80 years, at which time it may level off or decline going forward according to a study by the United Nations.  The upper limit of market size opportunities can grow beyond the growth of the human population as individuals become their own businesses too, the gig economy, increasing the volume of businesses to sell to.  The maximum size of a market could increase even further, even with human population decline, if digital twins or AI entities can become their own customers and businesses.  We know, it sounds crazy, but it is possible, and it is already happening. 

We may take a contrarian perspective and say that the future trillion-dollar companies will look nothing like the current chimeras we have today, the majority of which are currently digital first companies, the world of bits, and say they will look more like companies made out of atoms.  Tesla could be an example of this.  Future trillion-dollar companies may also be energy companies that do nuclear fusion, resource companies that do asteroid mining, or companies that do real estate construction and manufacturing in space, as there is more outer space for building real estate than on Earth — all possible, and are all market opportunities that VU Venture Partners fund has explored and / or invested in. 

Regardless of whether a company sells a digital or physical-based product, or the combination of the two, the point about the importance of market size is the same.  A company worth US1+ trillion has to be addressing an extraordinarily large market opportunity that impacts a very large population of customers.  The number of customers required to reach a US$1+ trillion valuation will be determined by the revenue model used, which will be either a high-price low-volume play or a low-price high volume play, or both, and the company’s revenues will then be multiplied by a revenue multiple to arrive at its valuation. 

VCs are unicorn hunters.  They are seeking to invest in companies that can be worth US$1+ billion in the future.  They target 10x-100x+ returns, and this can be achieved by investing initially at the ~US$10 million to US$100 million valuation range, and the companies exiting in the ~US$100 million to US$10 billion+ range.  The bigger game however is to focus on investing in companies that have the potential to exit at US$10+ billion valuations and that requires going after market size opportunities significantly greater than the initial VC threshold of US$10+ billion. 

Now to be fair, we could build a VC portfolio with solid 10x+ return exits with less than US$1 billion future exit valuations, but we need to invest early enough where the valuation is low enough to make that happen.  Example: VU Venture Partners invested in Bear Flag Robotics at a US$27 million valuation, and 14 months later, exited at a US$250 million valuation, with no dilution in between, yielding a ~9x+ return in a short period of time.  Doing this consistently in such a short time frame is quite rare and would not be something we would project to happen, although top investors often invest in a higher volume companies where this does happen. 

VU Venture Partners fund, for example, has had three exits recently which were positive exits between 1x+ and ~10x returns within roughly ~12 months of investing in each company, yielding a ~5%, ~17%, and 650%+ IRR.  For some of these companies, VU Venture Partners would have certainly liked the company to grow for a longer period of time, to reach larger milestones, and exit for larger amounts, but a win is win at greater than a 1x return in VC, and sometimes founders get early offers for acquisition that they have a hard time resisting. 

VCs love investing in companies that have IPO potential.  No one is in the VC business to focus on quick flips.  When a founder pitches their company as a quick flip for a 2–3x return, that is usually great for them, but a turn off for VC.  When a company has IPO potential, it means the company is going after a market size opportunity that is so large that if it executes successfully it could become so big that there will be few potential acquirers large enough to effectively acquire them.  The only way then to create liquidity for prior investors and founders and to continue to grow larger is as a public company. 

When a founder is focused on getting their company acquired by a larger company, that is an admission of the founder saying that what they are building has large potential, but not huge potential.  They are saying that the best projected future for the company is being a latch on entity to a larger company.  Companies that have huge potential do IPOs, and they then do the acquiring of other companies as they continue to grow larger.  Eventually, if they can grow large enough, they become the chimeras eating unicorns for lunch. 

Unicorns received their name initially for being quite rare as a mythical creature, and not for how cute they are, though that helped.  As new unicorns are being minted at an increasing rate, unicorns are not as rare as they once were.  At VU Venture Partners, the three investment partners have been some of the earliest and largest investors in 10+ unicorns.  We live in a reality where there are likely many more unicorns to come, many of which are in VU Venture Partners’ current portfolio, especially as companies become more capital efficient and are able to go after larger market opportunities, such as the space industry, biotechnology, robotics, AI, and so forth, have increasing access to capital at all stages and scales, and as the speed of innovation continues to increase. 

The north star for massive opportunities is no longer to become a unicorn, it is to become a chimera, and it is only fitting that one of the definitions for a chimera is “a thing that is hoped or wished for, but in fact is illusory or impossible to achieve.”  We now know that chimeras too, just like unicorns, are possible.  That bodes well for the future, as there are likely larger opportunities than the ones that the chimeras of today have chosen to focus on.  Some of these larger market opportunities may be areas that the current chimeras move into.  The current chimeras reign supreme and seem to be on track to only grow larger, that is unless the government breaks up such extreme multiheaded beasts into separate entities by deciding that something so powerful should not exist as a single entity.