A Short History of Unicorns
High-growth startups with big valuations have been around for a while, but the name “unicorn” is new. The term was coined by Cowboy Ventures partner Aileen Lee in a 2013 TechCrunch article. Lee wanted a word that would capture the essence of a group of tech startups that carried valuations over $1B and were founded in the US after 2003. At the time the article was published, she found 39 unicorns that met these criteria.
“Unicorn” is a loaded term, and just the name tells us a lot:
- Rare: Lee calculated that 1 in 1,538 software and internet companies actually made it to unicornhood—or 0.7%. A billion-dollar company doesn’t happen every day. Unicorns are rare success stories for everyone involved.
- Aspirational: Unicorns want to revolutionize the world. Early on, Uber wasn’t just about building an app that got you a car—it was about taking on entrenched taxi interests and giving consumers a better price. Unicorns are “on a mission to build things that the world has never seen before,” and they want to tackle new problems at enormous scale.
- Magical: Despite the massive valuations and all the press headlines, unicorns are elusive. A UC Berkeley Professor of Linguistics says, “the term romanticizes techno-companies: takes them from the remote and unintelligible to the magical and even lovable, while also being rare and powerful.”
Unicornhood is something we aspire to, but it also stands for a mythical creature that always seems to be just out of reach.
On Unicorns Now
Three short years after Lee’s TechCrunch article was published, the unicorn population has shot up. While still rare, there are around 208 unicorns around the world today, with a cumulative valuation of $1.3 trillion.
The name “unicorn” today means something very different. Unicorns are now painted as hungry, reckless, and irresponsible, often without a path to profit or ROI for investors.
Here’s a look at the current climate for today’s unicorns:
- Frankenunicorn: Like Frankenstein, unicorns today are seen as animated by unholy energy—without the artificial life-force of VC dollars, they would collapse. Bill Gurley, VC at Benchmark and investor in Uber and Zillow, says, “The very act of dumping hundreds of millions of dollars into an immature private company can also have perverse effects on a company’s operating discipline… they are pushing profitability further and further into the future, as well as the proof that their business model actually works.”
- Fueling bubble-speak: We talk about unicorns today almost sheerly in terms of valuations, but as Kirk Krappe, CEO of Appttus, says, this hurts the reputations of the companies involved while “exaggerating the popular impression of a tech bubble that’s ready to burst.”
- Misguided plans for domination: As Bloomberg’s Matt Levine writes, “The great unicorn dream is to be as big and successful as a public company right now, but to have a startup’s limitless ambition for the future.” Unicorns want to defy the laws of the market and reality, without holding themselves accountable to a “running scorecard” of actual performance and revenue.
Public opinion on unicorns has soured. Recently, some unknown pranksters posted flyers of dead unicorns around the Bay Area, warning Palantir employees that their stock options are “worthless” and telling them to “go on strike or take over the company.”
Still, every entrepreneur is chasing the unicorn dream, and the effect is felt throughout the startup world and on the bigger economic landscape.
The Technological Rise of the Unicorn
Even though the concept of the unicorn is relatively new, there has never been a shortage of super successful powerhouses in tech. At least one super-unicorn—a unicorn with a present valuation of $100B+—has been born in each decade since the 1960s. Unicorns today aspire to reach the heights of a super-unicorn. The $1B+ club is seen as just a way station for greater valuations.
What unifies the best (or most successful) unicorns is that each can be traced back to the start of a new era in technology.
|Apple, Oracle, Microsoft
Source: Aileen Lee, “Welcome to the Unicorn Club”
The earliest pre-cursor to the super-unicorn was Intel, which was founded in the golden age of the semiconductor. From the start, the company produced semiconductors twice as fast as anything the competition could muster. Cisco built the infrastructure for networks to scale, and Google and Amazon changed the way we used the internet.
The boom in the unicorn population today is equally fueled by technology:
- New tools, old industries. Smartphones, cheap sensors, and cloud computing have all accelerated the rise of the unicorn and allowed them to penetrate traditionally tech-adverse industries, from taxi cabs to hotels and beyond.
- The rise of “superplatforms.” Andrew Chen writes that “for the first time, it’s possible for new products to go from zero to 10s of millions of users in just a few years.” By leveraging platforms like Facebook and Apple’s App store, products can acquire a high-volume of users faster than ever before.
- Connectivity. There are almost as many cell-phone subscriptions today, at 6.8 billion, as there are people alive. With the surge in global smartphone use, companies can not only acquire more customers but also >connect with them more often, at any time or place.
What’s different about this new crop of tech startups, however, is that there are so many of them. It was once rare to see a privately held tech startup worth over $1B, and now they seem to be everywhere. The watering hole is crowded.
A Formula for Fertile Unicorn Territory: Why So Many?
“The ‘unicorn’ thesis is that America is leading the world in creating technologically advanced companies which will catapult the rest of the economy into a golden age.” — Henry Dampier, Rising Interest Rates & Fried Unicorn Meat
The simultaneous rise of so many unicorns is no fluke, but there’s more to it than easy and cheap access to great technology. While advances in technology can account for massive growth, there are three other equally important factors in play.
The Macroeconomic Landscape
Source: Andreessen Horowitz
One of the most surprising things about the unicorn market today is the massive shift in returns. Once public, the majority of wealth creation for these rainmakers is now private.
Venture capital firm Andreessen Horowitz created a detailed report on the shift. Companies founded before the year 2000, like Microsoft, Amazon, and Oracle, were mostly funded by the public market, meaning that returns on these investments have been largely public. The latest wave of unicorns—LinkedIn, Yelp, and even Facebook—have been fueled by venture capital dollars and private equity, and that’s where the lion’s share of the money has gone.
Today, tech startups are taking longer and longer to go to IPO. In the early 2000s, successful companies would IPO after about three years. Now, it’s closer to seven years. Companies that once would have gone public by now are holding late private rounds of funding.
There are a number of reasons for this:
- We’re in a super friendly fundraising environment. In 2007, the Federal Reserve set interest rates at around 5x what they are today. Since the 2008 financial crisis, central banks have set interest rates close to zero percent. Beyond just venture capital firms, private equity and banks have all rushed in to join the party, pumping up valuations.
- Nontraditional investors are taking part. Everyone wants a piece of the pie—mutual funds Fidelity and BlackRock are participating in late-stage fundraising in order to participate, instead of waiting until an IPO.
- It’s easier to stay private. An IPO costs an average of $13M for a company that’s raised between $100M – $200M (and bankers take a 7% cut). An IPO ushers in public scrutiny over profitability and accounting ledgers. Staying private is a way around this. Investor Tom Tunguz points out that “while private multiples have remained constant, public software multiples halved.” Not only is it costly to go to IPO, but there’s also less opportunity for easy cash.
- The Jobs Act of 2012. Before 2012, you could have 500 investors before the SEC forced you to go public. Now you can have 2,000. Regulatory shifts like the Jobs Act make it easier for small companies to raise more capital. It’s how a company like Uber can raise $2.8B in its latest funding round—more than Google’s initial IPO.
Not that long ago, a $1B valuation for a privately held company was almost absurd. Google only raised a Series A round of $25M, at a valuation of $37.5M before its IPO in 2004. Meanwhile, Amazon raised a Series A of $8M before going public.
Startups today are a completely different beast. Due to low interest rates and an increase in non-traditional fundraising, it’s easier than ever before to raise money. There are huge implications for this—easier to raise money, harder to go public.
Why it matters: Most of the unicorns in today’s market like Jet.com or Zulily focus on consumers. They depend on a high volume of people using their service every day. This wealth isn’t being spread back to consumer investors within the context of an IPO—and they’re unable to participate in private offerings.
The people who actually use these products and make these companies successful are excluded from seeing the upside from an investment perspective. While the users are able to access great products, they’re largely excluded from the massive wealth the companies create.
Companies: Prestige and Market Share
Being valued at $1B does great things for your bottom line, but it’s not just a financial boost. Breaking $1B is a psychological milestone. It indicates that your company is a real force, a business to be taken seriously. It has a cascading effect on the press, investors, and recruiting.
The danger is that unicorns are often too quick to expand before building up a proven business model. As Marc Andreessen says: “Excessive amounts of capital allow companies to hire like crazy rather than operate efficiently. Hiring is an easy-sounding solution to many problems startups face. But once a startup stops being lean, it can become slow to execute and mismanaged.”
To compete, you have to raise money and hire new talent, but the paradox is that the more money you raise, the larger the potential downside.
For many, taking on new funding isn’t seen as a choice. Bill Gurley points out that, “If you’re in the enterprise segment and your competitors are raising $150 million at high valuations and pouring it into sales, you either can do something similar or be conservative and no longer matter.”
What used to be “compete or die” is now “get funded or die.”
A lot of people see achieving unicorn status as the only way to:
- Recruit top-tier talent. When you join the unicorn club, the world looks at you differently. Everyone wants to work for a unicorn. Instacart CEO Apoorva Mehta said, “[A valuation of $2B] absolutely gives us credibility… it tells the world that we’re looking to build a long-lasting worldwide brand instead of looking to get acquired.”
- Win the public. Because of branding, scale and network effects, the common perception is you win in your market, or you fail. You know you’ve succeeded if the name of your company is used as a verb, like “Google” or “Uber.”
- Drive out the competition. With large war chests, unicorns aren’t afraid to burn cash to flame out the competition and increase market share. This war of attrition is especially fierce between Uber and a global alliance of ride-sharing startups, leading to big price-cuts and low margins. As Marc Andreessen tweeted, “in tech-driven markets, overwhelming economic return tends to go to the company with the highest market share.”
High burn rates and momentum built on speculative funding are a shaky foundation for long-term success—and they’re the new normal for unicorns.
Why it matters: When Good Technology, a mobile security startup, was acquired by Blackberry last September, employees suddenly found out their common stock shares were basically worthless—and they had paid taxes on them at previous valuation highs. Once privately valued at $1.1B, the company was sold for less than half that amount.
With high valuations, investors are often covered by downturn protections, but there’s no safety valve for employees. Their common stock holdings get diluted after each round of funding, and if the company’s valuation takes a hit, it’s the employees who will suffer the most.
After the dot-com crash, investing in tech cooled, and valuations remained relatively conservative. Many trace the turning-point to Facebook, which soared from a $10B valuation in 2009 to a market cap of $321B today in several short years. Fear of missing out drives higher and higher funding rounds—and, according to Gurley, investors are too scared of missing the next big thing to conduct “traditional risk analysis.”
As Fred Wilson, co-founder of Union Square Ventures and investor in companies from Twitter to Zynga, wrote back in 2010:
In particular, I think the competition for “hot” deals is making people crazy, and I am seeing many more unnatural acts from investors happening. If it were just valuations rising quickly, I’d be a bit less concerned. But we are also seeing large deals ($5mm to $15mm) getting done in a few days with little or no due diligence. Investors are showing up at the first meeting with term sheets. I have never seen phases like this end nicely.
Exits need to be higher and higher for investors to see substantial returns. Investing in “riskier” bets like tech-unicorns means a lower cost of capital than traditional investments, incentivizing larger rounds in an unvirtuous cycle.
The market today encourages (or scares) investors to pour cash into unicorns:
- Preferential treatment during liquidation events. Investors often cover themselves from downside, especially for later rounds of financing. Square’s Series E round, for example, included a ratchet that guaranteed a 20% return on investment.When the company IPO’d at $2.9B—half of the $6B it was privately valued at—Series E investors were issued around 5.3 million extra shares, or $63.6M, to guarantee their investment.
- Larger exits are needed to recoup investments. The boom in the equity markets have allowed venture capital funds to grow in size. Once, venture capital firms banked on seeing a couple of big wins at 20x returns in order to lift their portfolio. With larger-sized venture funds, VCs need bigger exits to deliver returns to investors. According to Aileen Lee, to return the initial capital of a $400M fund requires owning “20 percent of two different $1 billion dollar companies at exit.”
- FOMO. Bloomberg’s valuation formula for unicorns is (Founder’s hopes and dreams) x (How fast it’s actually growing) – (Downside protection x Investor FOMO). Investors overlook high burn rates and negative cash flow in exchange for high growth curves and the potential for massive returns. During valuation, operating costs are often ignored in hopes of massive upside.
It’s easy to blame the investors, but they’re just one of many habitants in this new ecosystem.
Why it matters: The exuberance that has led to massive valuations is likely quickly tempered upon the first hint of a downturn. This means that in the near future, it will probably be harder for all companies to fundraise, not just unicorns.
When public equity investors lose enthusiasm for high growth companies—especially ones that are losing money—it not only makes it more difficult for these companies to go public, it constricts the private market as well. This means that in the near future, it will probably be harder for all companies to fundraise, and not just the unicorns.
What to Do When the Market Cools
Journalists, VCs, and spectators love to draw comparisons between the climate of unicorns today and the euphoria of the pre-dot-com crash. But most investors and commentators agree that while the market cooling is inevitable, there are several important differences.
Instead of competing with other tech companies or selling enterprise software, the biggest unicorns today, like Uber and Airbnb, are built for consumers. By nature, their business models require more cash to scale. As tech analyst Ben Thompson says, the market today is fundamentally different from the one in 1999 because everyone now has a computer and a mobile phone.
Are we in a bubble? Possibly. But the market historically has laughed at attempts to predict bubbles. While not every VC is screaming bubble, none denies the reality of an imminent pullback in the market, which we’re seeing in early stage funding. Bill Gates has said that over the next two years, he would probably bet against “a basket of unicorns.”
If you’re running a company in this environment, you need to be prepared. Here’s what to focus on:
1. Growth and revenue. The most common criticism of unicorns is that they lack a clear path to profitability and ROI. Marc Andreessen appropriately tweeted, “When the market turns, and it will turn, we will find out who has been swimming without trunks on: many high burn rate co’s will VAPORIZE.”
To survive: Companies today need to keep their burn rates in check. By actually building and scaling a customer base (with revenue and all) they can get a leg up on less-focused companies whose concepts carry all their momentum.
Not all of the unicorns are struggling with lower valuations. Atlassian went public last December at a valuation of $4.2B, and on opening day, shares jumped 32%, increasing the company’s market cap to $5.8B. It’s a clear standout from the markdowns that have plagued companies like Square. As a Recode article describes, “a decade of profitability buys a lot of credibility” with investors. Having never taken venture dollars, and with clear profitability, Atlassian is doing more than weathering the storm—it’s winning.
2. Unit economics. Figuring out the right combination of partners, best practices, and platforms requires a massive juggling act for founders trying to get their business models straight. Unicorns that jump the gun and neglect unit economics and infrastructure overextend and fall to the earth.
To survive: Startups don’t have to be profitable right off the bat, but they do need to have a path to profitable unit economics and an end-game in sight. They need to invest properly in infrastructure and new talent. In the long-run, this is the formula for actual growth, and will outpace competition fueled only by venture dollars.
Instacart, for example, has focused intensely on reducing costs in its supply chain and optimizing for more efficient and larger batches of orders. By carefully scrutinizing metrics like “items per minute” and “lost delivery,” the company’s been able to increase delivery efficiency by 20% while cutting down on late deliveries by 25%. Instacart has actually been able to improve its service while scaling down costs.
3. Sustainability: The market is actively looking for reasons to doubt billion-dollar-or-higher valuations. The highest flying unicorns are subject to constant scrutiny, with the press screaming “bubble” and pouncing quickly on any missteps.
To survive: Evaluate vital metrics constantly to ensure you have the resilience to endure hard times. Develop resilience, and the backbone to stick it out when things get tough. Pore over details like customer sentiment, potential for brand growth, how well users respond to products, leaders’ pedigrees and track records, and so much more, with scrutiny and patience.
Chris Wanstrath, CEO of Github, says, “We took the funding because things are going well, and we want to accelerate our business.” Github is using its funding to expand a business that was profitable for four years before taking on new funding. Its business model has already been proven to be sustainable. If the market cools significantly, its $2B valuation might see a dip but its business model is fundamentally secure.
Dreams of Unicorns
What’s easy to forget in this environment is that the pursuit of unicorn-hood is grounded in the hustle. It’s carried forward by the drive to dream big and create new things. These are all things that we should celebrate.
When you look into the history behind unicorns and where they come from, you understand that entrepreneurship isn’t about trying to build a $1B+ company just for the sake of it. It’s about persisting in the face of the external forces and trends that ultimately define a business.