WHERE DO UNICORNS COME FROM?

What was once a myth and rarity is now an everyday story. ‘Unicorns’ are private startups whose valuations reached $ 1 billion. Reading out the mythological background of the unicorn on Wikipedia out of curiosity, the King of Ethiopia stateted that “it is impossible to take this ferocious beast alive; and that all its strength lies in its horn. When it finds itself pursued and in danger of capture, it throws itself from a precipice, and turns so aptly in falling, that it receives all the shock upon the horn, and so escapes safe and sound”.

I’d call the horn of the unicorn the funding received from Venture Capital firms and Private Equity, where all its strengths lie and which saves it from crashing when falling down. It may seem like a negative assumption but it’s not. Money and liquidity creates value and it is necessary to create disruption, we just have to assess which companies and deals create positive and which ones negative disruption. The goal is to create a company that can eventually thrive and stay alive without its horn, or the enormous cash injections. Many of these startups survive on enormous losses for years and years only thanks to the availability of cash.

I’m not going to argue here about whether there is a bubble or not, you’d have to look into every startup and determine whether they are overvalued or undervalued, as well as consider that every valuation is also determined by the rights attached to the investors’ shares.

The term ‘unicorn’ for startups was first coined by Aileen Lee in 2013. The massive increase in billion dollar startups is also due to changes in the early-stage financing markets: the push for fast-growth, the availability of VC and PE finance that allow companies to raise large amounts of cash without the hassle of going though an IPO, and the willingness of these investors to finance them at high valuations. I also believe that investors are able to finance them at high valuations because of the power that many of these financiers can exercise during a liquidity event, which in the case of unicorns can often be an IPO, or sometimes an exit by market-leading companies.

However, finance is not the only reason. Technological advanced are becoming faster and the expansion possibilities of companies are therefore multiplied. The internet has created completely new business models that weren’t conceivable before, allowing them to scale at massively fast rates, decrease prices thanks to economies of scale and by putting growth before profits. Globalisation trends such as a mobile workforce, the opening of global financial markets and corporate deals, as well as the immediacy of communication all help increase the scalability of these startups.

Many of these unicorn valuations depend on a story. Facebook and its success may still fuel the hopes of current tech startups, and how the first famous tech unicorn will keep developing will likely influence current valuations as well. That’s because at the moment, for some business models, growth has almost no limits. For now. At the same time, this feeds higher entry barriers, as growth fuelled by capital and availability of the latest technology has become a pre-requisite to even operate in some markets, pushing up valuations and growth projections.

It’s also difficult to speak of failure, because once you are able to raise funding rounds of hundreds of millions or more, you can acquire a variety of companies that in turn push up the company’s value, and create synergies with the current core business and increase the value even further. These unicorns, in effect, can even become an investment vehicle over time, just like many tech giants such as Amazon, Alphabet, Alibaba, Uber, Facebook, Salesforce and many others are now maintaining their leadership by investing in all new potentially relevant technologies, and often setting up separate Corporate VCs to do so.

Synergies can be created with acquired companies in a variety of ways: by selling more products to the current customer base, by expanding the sales channels, by achieving market leaderships and buying up competitors, by enhancing brand recognition, fuelling the creation of new technology and know-how by sharing expertise, and also economies of scale, which however is not the main motivator for early-stage exits.

The hype of some tech sectors certainly play a role in the overvaluation of early-stage startups, but these may last for a few years, as the fast pace of technology also means that hypes quickly move on to the next big thing, and mostly create positive returns from early-stage exits. However, the popularity of some startups, despite their losses, and the backing of investors make it easier for these companies to keep raising money, from the same or new investors, as in the former case the best way not to lose money on previous investments is to keep the fire alive until a liquidity event can take place. Creating unicorns or pushing for early-stage exits has become a business model by VCs, but there isn’t much to criticise, as this is a disruptive business model that can create great successes. Entrepreneurs are often complicit of this, as they can be attracted to the startup culture and take part in this game thanks to the availability of capital and the VC’s ability to help them achieve early-stage exits, sometimes even starting out with sub-standards ideas and products.

Bad investments and bad startup ideas are also culprits. If you have a portfolio of 10 companies, and 6-7 will fail, while 2-3 may just about return the initial investment or a little more, then you need 1 company that will exceed all expectations, and you’ll want to use all resources at your disposal to ensure that that company provides the highest possible return. But of course not all bad investment decisions are avoidable.

So where do unicorns come from? First, it’s the product of a pursuit of growth, and we know how to create growth in one sector by disrupting another sector. Unicorns are created by a cycle of availability of finance, avoidance of regulations, technology change and fast adoption, VC power and negotiation practices, the use of imprecise valuation approaches or sometimes inexistent math, synergetic acquisitions, scalability, popular startup culture, the story of successes of other tech giants, increasing entry barriers and the makeup of a startup portfolio. All these trends keep fuelling each other. I don’t know what could happen if one of these links goes missing, like one step in the assembly line in the unicorn factory fails; maybe you’ll just get a defective unicorn, and then just replace a part of the assembly line with a new piece.

The possibilities of unicorns are infinite, as there are countless strategies to be applied in the future, a variety of revenue models possible and high hope of continuous technology changes to fuel the growth and possibilities. As long as all this keeps being true. Despite the pessimistic reports of some experts predicting that the bubble will burst, this hasn’t happened yet. There will certainly be ups and downs, but unless the fast technological changes stop, the cycle may continue. There will likely be some large unicorns that will fail and lead to more cautious investing and generally lower valuations. However, creating unicorns is part of VC’s disruptive business model, so unless some other catastrophic event takes place to change market dynamics, this cycle is likely to change when new financing methods and trends will disrupt the VC market. (I’m not talking about ICOs, I don’t think we’re there yet.)

 

Yes I know that the picture is an alicorn, but I like it better