We asked the founder of a tech advisory firm with over $1 million in revenue per employee how they sort the real unicorns from the pretenders

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• Union Square Advisors is a boutique investment bank focused on tech companies.
• Now in its 10th year, the firm keeps tabs on all the unicorns roaming the world and primarily works on transactions in the $1 billion neighborhood. 
• Founder and chairman Carter McClelland says sorting out the real unicorns from the pretenders requires investigating businesses up close and knowing every single board member and investor. 
• Union Square is private and doesn't disclose revenue, but it has had record performance in three of the last four years, and the firm pulls in well over $1 million in revenue per employee, McClelland said.

The past decade has seen an unprecedented rise in tech entrepreneurship, with $1 billion "unicorns" morphing from a rare creature to a mundane sighting in the process.

And as enthusiastic investors clamored to grab equity in the next Google, Facebook, or Uber, many entrepreneurs have commanded valuations inflated more by hype and gusto than true potential. Besides inducing a chorus of "bubble!" proclamations, this has also led in recent years to some painful initial public offerings as well as late-stage investments at deflated valuations.

Blue Apron and Cloudera, for instance, each saw their valuations buckle under public market pressure this year. 

Union Square Advisors — a boutique investment bank tailored toward tech mergers and acquisitions — has had a front-row seat for the whole spectacle, getting its hands dirty assessing startups and entrepreneurs for the past 10 years. 

Carter McClelland, a technology investment banker who first started covering the space in the the 1970s with Morgan Stanley, left his job as chairman of Bank of America Securities in 2006, believing that if he assembled a crew of bankers that actually understand tech, he could steal advisory business away from the bulge bracket banks that dominated the arena. 

So far, it's worked out for the Union Square founder, partner, and chairman, whose company primarily focuses on deals in the $1 billion valuation neighborhood and below but has in recent years worked on deals involving Dell, eBay, IBM, Nasdaq, and Salesforce.

Part of the strategy at the tech investment firm — a team of less than 40 bankers — is to keep close tabs on the more than 150 unicorns roaming the world, as well as the portfolios of the top venture-capital firms.

"We have a very sophisticated venture portfolio inspection system. We know, we think with pretty good accuracy, where the next 400 companies are coming out of the top-30 venture capital funds," McClelland told Business Insider. "So we cover those to try and be in the way of exits as they occur." 

Sorting the real unicorns from the pretenders

Because there's so much capital available right now — dry powder to invest has been at all-time highs in venture capital and private equity — there are more competitors with funding working on a given idea or technology than there really should be, McClelland said.

Seven startups have venture backing where there's really only room for two or three. Hence the rash of tech companies experiencing painful revaluations. 

He said his bank has advised a couple tech companies this year that raised capital at a valuation over $1 billion but now are reckoning with the prospect that they're actually worth half that.  

"You just have to go to these meetings and listen to the gnashing of teeth," McClelland said. 

McClelland estimates about a third of unicorns will fail, another third will take a decade to grow into their business model, and the last third are more imminent winners on the track for initial public offerings.

So how does Union Square sort out the true gems from the pretenders? 

"You meet with the companies, you figure out what the business plan is, you try to assess whether it has legs and is it going to survive," McClelland said. "You've got to know every single board member and investor, because they're not aligned."

One mistake McClelland often sees is VC investors cowing to a confident, charismatic startup CEO who's convinced success is right around the corner when in reality the company is headed toward the scrap heap. 

"I think this is just the nature of America, technology, and entrepreneurs — it's their baby, right? Quite frankly, venture capitalists are susceptible to, 'Just give me another year, and I'll get this right,'" McClelland said. He continued: "They did it because they think they can build something great, and they maybe take longer to give up than they practically should."

"We usually just get the phone call."

But business is good for McClelland's boutique investment bank, which celebrated its 10th anniversary in 2017.

The firm is often approached directly to work on deals rather than having to pitch its capabilities or compete in a "bake-off" with other investment banks, according to McClelland. Of the roughly 50 assignments the firm typically secures each year, it competes for less than 10% of them, he said. 

"We usually just get the phone call. And we don't get it just because we're tall and good looking, we get it because we've invested a year or year and a half with these companies, we get way ahead of the decision, and by the time they have to make the decision, we're the choice," McClelland said.

He added the caveat that many firms they're hunting don't wind up in their laps, of course. "It's not a 1,000% batting average."

Union Square is private and doesn't disclose revenue, but it has had record performance in three of the last four years, and the firm pulls in well over $1 million in revenue per employee, McClelland said. And given their size and lack of overhead, employees will keep most of that cash, too.

"Part of the reason you see so much more of the M&A business being done in boutiques is just because it's a better model," McClelland said. "We pay our people a lot more than what the big banks can pay their people."

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