In the world of investing, a growing number of starup companies have reached billion-dollar valuations; they’re called unicorns. But what does it take to be part of this club, and should investors put funds behind them? Let’s start with the basics.

What is a unicorn?

A unicorn is a privately held startup company with a valuation of $1 billion or more. The term surfaced in the last decade when Aileen Lee, the founder of a Palo Alto–based venture capital fund, wrote an article about 2000s tech startups and found that less than 1% of them had reached billion-dollar valuations.

What kinds of industries do unicorns typically fall into?

Unicorn companies are typically innovative or disruptive companies that are expected to grow quickly. There are an estimated 1,101 unicorns around the world, according to CB Insights, with a cumulative valuation of $3.67 billion (or an average of $3.3 billion per unicorn).

"Unicorns tend to appear where there is a lot of fast growth in the tech space and large markets," says Julien L. Pham, founder and managing partner of Third Culture Capital (3CC), a venture capital firm whose mission is to advance equity and diversity in health tech innovation. "[That includes] e-commerce, deep tech, SaaS (software as a service), mobile, fintechs, and of course, but not as often, health care. On rare occasions, new markets are 'established' by unicorns."

Currently, the top 10 unicorn companies are:

1. Uber

2. Xiaomi

3. Airbnb

4. Palantir

5. Didi Kuaidi

6. Snapchat

7. China Internet Plus

8. Flipkart

9. SpaceX

10. Pinterest

How are unicorn valuations determined?

It involves some guesswork. Because unicorns are startups without a long track record, their valuations are typically based on how investors and venture capitalists think a certain company will perform over time. Sometimes this involves using a competitor's performance as a foundation to determine how a startup might perform. The catch: A lot of these companies are the first of their kind, so it can be tricky to determine how they might grow, if at all.

As time has passed, more and more companies are reaching that $1 billion valuation and far exceeding it, with companies like TikTok and its parent company valued at $50 billion and $300 billion, respectively. This has left some investors wary about whether these valuations are fair or if they could be contributing to a potential unicorn bubble.

“The exercise of valuing a private company in recent years has always been a bit of an art form,” says Pham. “Given the bullish market environments, companies with $1B valuations 'on paper' were based on many investors trying to get into a deal and artificially raising said valuation. It is important to know who the co-investors are and what their ongoing roles in helping build and scale the companies are, versus investors who are there for the ride.”