Bearing little in common with the horned creature of legend and fantasy, unicorns of the information age are defined by being a private company valued at over $1 billion.
Fuelled by the technology boom and an iffy stock market, the world population at the end of 2014 was 75. This year, it’s 140. Some would argue it’s already silly to give something that’s now so common a name that implies scarcity. Considering the name was only invented at the end of 2013, by Aileen Lee of Cowboy Ventures, the rise and rise of unicorns seems inexorable.
Why has 2015 in particular been such a fertile year for unicorns? It’s not as if tech start-ups are a new invention – people could have started throwing big money at them long before now if they’d wanted to. John Mullins is Associate Professor of Management Practice in Marketing and Entrepreneurship at London Business School. He’s also author of ‘The Customer-Funded Business’, a book that looks at where entrepreneurs should look for funding to get their ventures off the ground.
‘It’s interesting and crazy’, he says. The reasons for the explosion are myriad. Known as ‘alternative investment’, many pools of money – like investment bankers or hedge funds – have a big hunk of cash that they set aside every year to play around with something a bit different. Traditionally, they’d take a gamble on the stock market but at a time when you’d probably get more back on the football pools than you would there, they’ve become infatuated with incredibly fast growing companies like Uber, now valued at $51 billion.
John says ‘Unicorns are making headlines with the capital efficiency of their growth rates. Take Uber – they don’t have overheads for a factory, they don’t need an inventory of parts. It’s what I call a matchmaker business.’ The lack of interesting alternative homes for their money combined with the fact that a little bit of investment goes a very long way – because they are largely funded by their customers – makes unicorns irresistibly seductive to investors right now.
‘It’s like the Dutch tulip phenomenon,’ says John, referring to the years in the 17th century when tulips in the Netherlands grew so popular that you had to earn 300 times the average salary to buy one bulb. ‘People think if I can get on this early enough I’m going to make a ton of money. The bubble’s peaked. There’s beginning to be evidence that the valuations of these unicorns are way too high.’
If a unicorn wants money to open in 10 new countries, for instance, it can approach a hedge fund and ask for it. If it was worth $500 million at the time of its last financing round and the hedge fund gives them $100 million, a fast growing unicorn may be able to convince the hedge fund that it’s now worth $1 billion. So the company only has to give up a small share of its equity to raise a large amount of money. So far, so bubbly.
‘They would rather be private than go under the scrutiny of Wall Street or the City of London’, says John. ‘That’s very onerous. So if you can raise money without doing that, great. ’And, of course, because these companies grow so fast, they absorb a lot of capital. So you can understand that they’d rather take it privately.
Uber is now valued at $51 billion, so is, in fact, a ‘decacorn’ – a private company valued at over $10 billion. How long until they get to $100 billion? What are we going to call Uber then? A centicorn?
If you get on the FTSE index and look at the other companies worth $50 billion, they’re big global companies, not some five-year-old start up. ‘This is a bubble, and it will burst,’ says John. ‘The reason it will burst is because at some point, the music has to stop. At some point, these companies will have to get sold.’
So what’s the problem? Someone will buy them and it’s a win/win, right? Unlikely. VCs have funds which they take from pension companies and the like. They invest it in something like Uber, but at some point they have to take it back and say to the pension fund ‘aren’t we clever – look at what we got back from your investment’. There’s only two ways to do that – sell the company or IPO it.
‘Who’s going to write a cheque for $51 billion to buy it? Who’s going to buy all these unicorns?’ asks John. They could go public. But then the public market will say ‘What’s this company worth? Is it worth as much as Tesco? As Amazon? ‘My guess is that there’s not enough private buyers with enough money to buy them, and if they want to go public, the market will not match these valuations.’ That’s exactly what recently happened with the Square IPO, when the public market valued the company at only about half of what earlier investors had paid. It’s a point that rings true. Look at the post-IPO nose dives of Groupon and Zuliliy. Google’s not going to buy all the unicorns. Apple’s not going to buy them either. So with a dearth of companies with pockets deep enough to buy a unicorn, and with the public probably scoffing at what unicorns’ most recent investors said they were worth, we have a problem.
There are people who’ve been quick to liken the unicorn phenomenon to events leading up to the 2000 dot com crash. And, of course, it does bring up a slight feeling of deja-vu. ‘But they didn’t have customers and revenue back then and we do!’ you can almost hear the unicorns neigh in unison. ‘They don’t all have customers and revenue’, says John. ‘Some do. But the big question is, do they have enough customers and revenue? Time will tell.’