Unicorn spotting

As learning – for now – is confined largely within computer screens, the coronavirus crisis will give rise to a wave of new ed tech businesses. Investors are striving to spot the next unicorn before its valuation balloons, but how does one tell it apart from a donkey? Simone Rensch finds out

Unicorns – businesses valued at $1 billion or more hundreds – if not thousands – of competitors peddling a – are mystical creatures in the ed tech arena. As of similar line. So, how can investors separate the good from January, only 14 existed, according to Holon IQ, the bad, the unique from the banal, the original from the a data provider. Investors are fascinated by the prospect imitation when ploughing tens of millions of dollars into of spotting one before its valuation rockets, yet few loss-making fledgling companies? actually do. And, as the Covid-19 pandemic grinds on “The secret is to find and recognise them before anyone and continues to confine learning to virtual environments, else notices them,” says Michael Staton, partner at Learn the global ed tech sector is poised for further saturation. Capital, a venture capital fund focusing on education that So, EducationInvestor Global crafted this field guide to backed Coursera and VIPKid, two unicorns. unicorn spotting, amalgamating advice from successful investors and industry experts to help you pick winners People, not product and avoid donkeys. Investors agree that one of the most important aspects of an ed tech business is who’s running it. Staton says that The current landscape he looks for founders whose roles are “what they were just The global ed tech industry has spawned numerous unicorns meant to do with their lives”. However, any investment over the past 18 months. In May, virtual decisions ultimately rely, to varying flashcard platform Quizlet reached extents, on intuition, he says. But the unicorn status after raising $30 million more time spent with management teams, in a Series C funding round that valued the more refined one’s ability to spot the business at around $1 billion. At the You want founders success becomes: “In theory, once you end of last year, language-training app that are going spend 10,000 hours meeting teams, you Duolingo became a billion-dollar business following a funding round in which it also raised $30 million. According to HolonIQ, to be with the company for at might have a better ‘Spidey’ sense. You might be more attuned to some of those subtle things that are hard to articulate.” the world’s 14 ed tech unicorns – all of least five years If a business has more than one founder, which are Chinese, American or Indian it is crucial that they have a strong bond – have collectively raised more than $6.6 and shared long-term vision, says Staton. billion over the past decade. “Half of the times that companies die at

China made up more than half (52%) an early stage it’s because the founders of the past decade’s ed tech venture capital funding, while break up,” he says. “You want founders that are going to the US represented 33%, followed by Europe, India and be with the company for at least five years.” the rest of the world, each contributing about 5% of global Adaptability is key, too. The coronavirus crisis has shone funding. HolonIQ expects more than $87 billion to be a light on how quickly even a recession-resilient sector invested in ed tech over the next 10 years – almost triple like education can be uprooted. Successful ed techs require the prior decade. While these figures may seem impressive management teams that are versatile and able to pivot in isolation, ed tech expenditure accounts for less than 3% products and offerings to the market’s changing wants and of global education spending. needs. Charles McIntyre, co-founder and chief executive of

Despite often having millions of users, many ed tech Ibis Capital, which backed public unicorn Meten Edtech X, businesses – even unicorns – fail to turn a profit, as costs explains: “The management capability for us is much more related to the acquisition of customers often exceed what focused around the versatility and ability to pivot when an they spend. A common trait among ed techs is that they opportunity is identified.” This trait is particularly important claim to be “the best” at what they do, despite often having when it comes to early stage investments, he adds. ▶

▶“Businesses that are very successful are sometimes two or three deviations away from the original business concept or idea because they’ve grown in response to the market,” says McIntyre. He and his firm tend to avoid “people who have identified one pain point in the market and think they have the panacea for that without working out the real commercial proposition and the underlying trends within the ecosystem”.

Janine Manning was one of the first angel investors in Crimson Education, a $260 million ed tech company which specialises in college admissions consulting and also has an online high school. Recalling the investment, she reflects on the robust capabilities of Crimson’s founders, who were just 18 years old at the time. Manning, who is a director of Crimson, says: “First and foremost, I looked at the jockeys – and it quickly became clear that the jockeys were sitting on a pretty good horse. It always has to come back to people – it is people who are going to have to execute. You want to look for ambitious founders.”

Getting things done While the idea and subsequently the business is obviously important, the process in which things are done within a start-up is another crucial indicator of whether an ed tech business holds unicorn potential. Staton, of Learn Capital, says: “Good investors pay attention to process. In addition to evaluating people, their character and their skills, you need to look at how the company is managing itself.”

This includes whether they are efficient with cash, have the right systems in place and how they prioritise strategic decisions and goals, for example.

“There’s a catch-phrase that most companies don’t starve, they drown. This means that they kind of die from taking on too much, and running out of money,” says Staton.

According to Staton, business with unicorn potential showcase growth in revenue of at least 10% a month, or expand their userbase by 30% over the same period.

“Once a company starts to achieve these different growth rates, a lot of the other indicators matter less and the company starts to achieve high valuations relative to their trailing fundamentals.

“If you’re trying to spot a little pony that will grow into a unicorn before anyone else spots it, you pay attention to people, process and positioning, a lot.”

But if investing later, at a growth stage, in companies that have “already made it”, this matters less and the business fundamentals matter more, he says.

Early doors and potential flaws The tricky part about assessing the value of early-stage companies is that widely monitored business metrics, such as EBITDA and profit margins, are in negative territory on balance sheets as profit is used to finance further growth. Investors must seek out other indicators, many of which are less tangible and so harder to gauge.

“Sometimes at the very early stages, the evidence of performance and outcomes and be quite anecdotal,” says Elizabeth Wills Chou, investor at Leeds Equity Partner, a US-based private equity fund that invests in knowledge industries.

One essential aspect of any start-up, though, is the value it adds, she says, suggesting that investors examine the impact a business has made on its industry or clients.

“It’s a matter of speaking to the users and understanding how a tool is being used. At the early stages, you’re sort of looking for indication that this product is improving student learning, access, retention, engagement or leading to gains in learning and workforce advancements, for example.”

If a business adds value and has impact, the likelihood is it will turn into a profitable venture, she says.

Scaling for success No investor has a fool-proof formula for predicting ‘potential’. It’s a buzz-term among investors, yet most struggle to point to exactly what it comprises. One component that is frequently referenced, however, is scale – or, rather, a company’s ability to achieve it. Pablo Langa, managing partner at EDT Partners, a global education consultancy, explains that ed tech businesses unable to generate revenue beyond their home markets will struggle to attract the attention of investors.

“You have to be able to demonstrate that you can operate at a global scale,” he says. “Anyone who wants to be something relevant has to be able to scale. You can’t put all your eggs in the US or Chinese market.”

Even then, scalability on its own is not enough, as scale is relevant to the size of the market within which a company sits, and competition levels.

Ibis Capital’s McIntyre says that investors who understand fully a market’s nuances have a better chance of building a unicorn within it.

“It’s about understanding potential within the context of what is realisable within the market – that is key to identifying what is going to be successful and what’s not,” he says. ▶

▶For instance, selling new content or technology into schools across Europe may sound like a great opportunity, until one looks at the complexity of the buyer landscape: multiple budget holders, varying education systems and language barriers.

“It’s about understanding how the jigsaw fits together and whether you have the right team to complete the picture,” says McIntyre.

Nothing comes for free While some investors, when assessing the potential of early-stage companies, consider user growth a key indicator of success, others prefer to reference oldfashioned financials.

Melody Lang, founder and director of MPA Education, which invests in ed tech businesses, says: “The companies and solutions that gain traction based on their user

numbers and not revenue potential really freaks me out.”

She explains that monetising an ed tech solution with thousands, if not millions, of users can be “tricky”, adding: “You have to be really clever in education in the way that your end user is not always your end customer.”

Some ed tech unicorns with little or no margins and eye-watering valuations give weight to Lang’s concerns. VIPKid, which connects English-language teachers in the US with hundreds of thousands of Chinese students via its platform, reportedly struggled last year to raise the $550 million it sought amid concern among investors that its strategy to chase scale over profits was detrimental to its long-term success. GSX Techedu, a publicly listed Chinese competitor to VIPKid, has been accused by several short-sellers of fabricating its user numbers to woo investors.

Patience is a virtue (that private equity says: “Venture capital embraces chaos, while private doesn’t have) equity embraces control.” Almost all ed tech unicorns are born and raised on venture On the quest for a unicorn, investors need not only capital. Venture capitalists, the managers of funds for to be patient when it comes to returns, but also when fledgling companies, place lots of relatively small bets finding companies and management teams worth backing. in the hope that perhaps one or a handful will pay off “It takes a lot to get our chequebooks out but it doesn’t much later down the line. take a lot to get our attention,” says Staton, who reckons

“It’s sort of like posh gambling,” says angel investor he invests in just one out of every 200 businesses that Manning, whose consortium recently sold 5% of its he meets with. shares in Crimson Education for a price that represented 59-times its earnings. The investment No magic formula had tripled in value. The world of venture investing is

Venture capitalists tend not to take wrought with complexity and unknowns control of businesses, and instead let and there is no magic formula for the founder-managers steer the ship. Venture capital’s older sibling, private The issue of most success, but it’s worth remembering the four P’s – people, process, potential equity, on the other hand, tends to buy financial investors and patience – when placing bets on majority stakes in businesses with the is that their horizon fledgling firms. aim of selling them on for a profit is four-to-five years. Identifiable points of differentiation typically within five years or less. In this market, are also essential when developing But ponies don’t grow into unicorns overnight, says Ibis Capital’s McIntyre: you probably need unicorns in saturated markets (just search ‘maths solver’ in your “The key message for this type of more like sevenmobile phone’s app store to see for market is about having patience in to-nine years yourself). terms of building businesses because “Around the world, we see way the cycle is longer. The issue of most too many players doing the same financial investors is that their horizon thing,” says Langa, of EDT Partners. is four-to-five years. In this market, “I’m not going to say all the wheels you probably need more like sevenhave been invented – but they to-nine years.” pretty much have.”

Some take an even longer view. “We look to build Winners are willing to embrace consolidation, says a portfolio where the valuation 10 years from now Langa, in order to gain market share more quickly. is exponentially larger than today,” says Staton, of “Governments, school networks and universities can Learn Capital. only work with so many providers in one segment,”

He says that venture capitalists expect “to lose money he says. “With the growth of similar niche initiatives, on 30-40% of investments”, while 10-20% will “create relevant market share will have to be achieved via exponential returns that drive value”. In summary, he business consolidation.” n