Unicorns vs. Dragons

In VC, a ‘unicorn’ is a private company that is valued at over $1BN. Considered the gold-standard, funds often invest with the single aim of backing future unicorns.

In 2021 and 2022, we saw more money raised and invested by VCs than ever before and subsequently record highs in the number of companies achieving unicorn status.

Since mid-2022 however, a change in market sentiment has seen companies raise at more conservative valuations and the number of newly-minted unicorns has dropped considerably. 

Number of new unicorns (globally) by month

Source: Pitchbook

If a business is looking for VC funding, it should be their aspiration to become a unicorn.

But as an LP, there are a few things to consider when it comes to unicorns:

  • Does it matter if my funds have unicorns in their portfolios? 
  • Will the decline in unicorn numbers negatively impact the performance of my LP investment?
  • Do unicorns always mean great fund returns?

At Sprout, we’re challenging convention around unicorns and believe that LPs should be discussing the lesser spotted dragon over the unicorn.

What is a Dragon?

A dragon is a business that, on exit, returns the entire fund to the LPs – i.e. a business that returns $200m to a $200m fund.

Ignoring all other incentives to invest (social impact, supporting friends or family etc), the key reason for investing in funds is to make money. The dragon is incredibly important in all this and something to look out for when identifying potential VC Funds to invest in.

Aren’t all unicorns dragons as well?

No. According to TechCrunch, dragons are four times rarer than unicorns.

Let’s look at some fund economics with the below example:

  • A VC Firm has raised a $100m fund
  • It will invest into 20 companies
  • It will invest $5m into each company…
  • And receive 20% equity of the business
  • The firm does not follow on with any further investments into its portfolio companies.

In this fund, there are two breakout stars: Company D and Company U.

Company D

Stage 1: The Growth
Company D reaches profitability without the need for further investment.

Stage 2: The Equity Stake
The fund has retained its 20% equity stake in the business.

Stage 3: The Exit
Company D exits for $500m with minimal fanfare. A great exit, but not a unicorn.

Stage 4: The Return
The return for our fund from Company D is $100m (20% of $500m). A return of 1x of the fund.

Company D is officially a dragon.

Company U

Stage 1: The Growth
Company U on the other hand grows significantly and continues to raise more funding from other venture capital funds.

Stage 2: The Equity Stake
The stake that the fund retains in Company U is diluted across funding rounds and ends up at 5%.

Stage 3: The Exit
Company U hits unicorn status and exits via IPO for $1.5bn. A huge win for all involved (and 3x bigger than Company D).

Stage 4: The Return
The return for the fund from the IPO of Company U generates a $75m return for the fund (5% of $1.5bn). A fantastic return, but only 0.75x the fund.

Company U is a unicorn, but not a dragon.

As we can see in the above examples, both companies are successful and are strong exits for the fund.
Unicorns are important, and exciting. They should be celebrated. However, don’t be afraid to look beyond the logo, and hunt for dragons.

Capital at risk. T&Cs Apply. Nothing in this article constitutes investment advice. —