Unicorns are private companies with valuations in excess of $1 billion. Facebook and Google were the pioneers and Uber, Airbnb, Snapchat and Pinterest are some of the most dominant unicorns today. CB Insights recently estimated the aggregate value of all of today's unicorns at a
breathtaking $599 billion.
Our industry has its own rising unicorns. Three recent transactions highlight a few of them. Like many unicorns, valuations are not based on traditional measures like profits or cash flow, but instead on future potential.
UNICORNS IN OUR INDUSTRY
Betterment,
Wealthfront and Personal Capital are the closest companies to unicorn status in terms of valuation multiples, while the sale of Edelman Financial brought them the closest to a private billion-dollar threshold in total value.
Betterment recently
raised $100 million at a $700 million valuation, Personal Capital
raised $75 million at a $425 million valuation and Edelman Financial was purchased for more than
$800 million. In 2014, Wealthfront
raised $64 million at a $700 million valuation.
Let's do some math to estimate multiples paid for these rising unicorns. These are rough estimates imputed from public information.
• As of March 31, Betterment reported AUM of $4.5 billion in their ADV. Their max fee is 35 basis points but drops to 15 basis points on assets over $100,000. If we take a blended average fee of 25 basis points, the company went into the second quarter generating an estimated $10 million in annual revenue after eight years and $205 million of capital raised.
• Personal Capital reported AUM of $2.1 billion, according to their ADV. Their fees start at 89 basis points and drop to 69 basis points on assets up to $5 million. Using a blended average of 79 basis points, they went into the second quarter generating an estimated $17 million in annual fees after seven years and $170 million of capital invested.
• Edelman Financial reported $15 billion of AUM as of Dec. 31, 2015. Using a blended pricing of 1% (their ADV goes from 2% for a $150,000 account to 65 basis points for a $3 million account), they were generating an estimated $150 million in annual revenue coming into the first quarter.
Based on these assumptions, Betterment raised money at 70 times revenue, Personal Capital at 26.5 times revenue and Edelman sold for 6 times revenue. Clearly not all unicorns are created equal.
As a comparison, the typical independent adviser sells their firm for a little over two times revenue.
Why do firms receive such disparate valuations? There are two distinct drivers:
1. The size of the addressable market. The larger the serviceable market, the greater the future earnings potential and the higher the multiple paid. Investors assume that Betterment is untethered to geography or client size and they can be the investment manager to everyone because of their low cost. Personal Capital has a technology-based virtual offering, but has higher pricing, higher minimums and slower growth. On the other hand, Edelman is predominantly office- and people-based and has the highest fees, but it uses technology aggressively to expand their scale and margins. By comparison, the typical independent adviser has the greatest constraints, and therefore cannot receive platform valuations.
2. Core operating profit margins. The higher the variable cost, the lower the operating margins. In our industry, people are the highest variable cost. The less people-dependent the business, the higher the potential margin and the higher the multiple. Betterment has no advisers. Personal Capital has them, but they each service many hundreds of clients. Edelman has humans, and while they have scale, it's far more personal than the other two. By contrast, the typical independent advisory firm has a one-to-one relationship with each client and very little scale.
BELIEVING IN UNICORNS
What ultimately drives the increased valuations of unicorns is technology replacing humans. This drives costs down and can be applied to a very large universe. In essence, the valuation is a reflection of an investor's convictions that a firm can replace variable costs (people) with a fixed cost (software and computers). If it turns out to be true that consumers don't need humans to make smart financial choices, then unicorns will fly. If, however, that turns out to be wrong, these valuation multiples will adjust to reflect that. Time will tell.
Nonetheless, there's a lesson here for any adviser wanting to create a more valuable enterprise: Reduce your reliance on people by increasing your use of technology and have the ability to expand beyond your geography. In short, the future for any really valuable firm really is bionic.
Joe Duran is chief executive of United Capital. Follow him @DuranMoney.
