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Predicting a Unicorn Startup [Startups
Posted on March 23, 2016 @ 02:40:00 AM by Paul Meagher

Y Combinator is currently the top business incubator in the world so it is a worthwhile exercise to study the W2016 round of startups featured at their recent Demo Day launch event.

Tech Crunch is covering the Y Combinator Demo Day launch event and you can read about the 60 startups that presented at Demo Day 1. As you read through them you might ask yourself which of these companies will be the most successful? You might also ask yourself if there is a "Unicorn Startup" in this batch? In Silicon Valley, a company the size of Google, Facebook, Twitter, LinkedIn and so on is called a "Unicorn Startup" or simply a "Unicorn" - a mythical and rare creature mentioned in this interview. Silicon Valley investors are often hoping to find the next Unicorn. A Unicorn can be defined as a company with the potential to achieve a 1 billion dollar valuation in the next 6 years. Which company in this batch might be the next Unicorn?

In a recent series of blogs (see Financial Forecasting, Updating Forecasts, Evaluating Forecasts) I discussed Philip Tetlock and Dan Gardner's book Superforecasting: The Art & Science of Prediction (2015). One of the take home messages from that book is that if you want to become a better forecaster you need to make testable forecasts and then evaluate how well those forecasts fare. The quadratic scoring technique is a simple and flexible technique that can be used to evaluate forecasts accuracy and to guide you to becoming a better forecaster.

The Y Combinator Demo Day events provide an ongoing opportunity to hone your forecasting skills in the domain of startup investing. Here is how it might work. Pick one or more startups from this batch that might be a Unicorn startup. Now assign a probability score to your forecast. Evaluate that forecast when the next Y Combinator Demo Day event happens and make new Unicorn forecasts and adjust your previous Unicorn forecasts as necessary. Do this for awhile and you will improve your knowledge of and skill in Unicorn forecasting.

I think there may be a Unicorn hiding in this batch of startups. To make a defensible prediction I would have to read more about these companies but my gut suggests that Magic Instruments might be a possible Unicorn. Magic Instruments is redesigning the guitar interface to make it easier to learn and use on an ongoing basis.

Magic Instruments is charging a reasonable price for the guitar ($299). They have a revenue model that also includes ongoing fees from customers ($6 monthly subscription service for chords and lyrics of popular songs). The trade name, Magic Instruments, is very fitting. Finally, the success of Guitar Hero established that the market for electronic guitars and software can reach up to 6 billion dollars. On the downside, it is one thing to claim to be able to redesign the guitar interface, it is another to actually pull it off. There are competition and patenting issues that are unknowns. I don't know anything about the management and what the financial situation of the company is. Really not the best situation to make a prediction but for the purposes of this blog I'll go with my gut and test how good that method is.

So what probability should I assign to Magic Instruments being a Unicorn? If I think they might be a Unicorn then from a semantics point of view the starting point for my assignment should be above 50% to make it a non-trivial prediction that can be evaluated. I'm not that confident in this forecast so I'll say it is 60% likely to occur (i.e., p(MI = U) = 0.6). I won't say I'm 56% confident because claiming such accuracy would be misleading. I'm implicitly claiming accuracy to within 10 percentage points at this stage.

Predicting Unicorns from Y Combinator Demo Day events is a fun pastime that could also be a teachable moment for would be private investors on picking the next big thing.

At last count, VentureBeat listed 229 unicorn startups with a disproportionately large number (101) located in California (image below from VentureBeat article). A non-trivial portion of that number were incubated by Y Combinator so this method of predicting unicorns has a decent chance of succeeding.

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