The venture-capital boom is a risk for investors—and a gift for everyone else
ILEEN LEE, a venture capitalist who founded an investment firm called Cowboy Ventures, coined the term “unicorn” in 2013 to refer to what was then a rare, mythical species: privately held startups valued at $1bn or more. Any magical attributes aside, today they are commonplace—and becoming ever more so. Consumers, who stand to benefit from an array of novel, often cheap products and services, can expect to enjoy the ride. Investors betting on the unicorn derby should tread more carefully.
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The world’s unicorn herd is multiplying at a clip that is more rabbit-like. The number of such firms has grown from a dozen eight years ago to more than 750, worth a combined $2.4trn. In the first six months of 2021 technology startups raised nearly $300bn globally, almost as much as in the whole of 2020. That money helped add 136 new unicorns between April and June alone, a quarterly record, according to CB Insights, a data provider. Compared with the same period last year the number of funding rounds above $100m tripled, to 390. A lot of this helped fatten older members of the herd: all but four of the 34 that now boast valuations of $10bn or more have received new investments since the start of 2020.
The latest tech darlings are no longer primarily Uber-esque marketplaces for matching services with consumers. Instead, they offer, or are developing, sophisticated products, often in more niche markets. Some 25% of the funding in the second quarter went to financial-technology firms, with lots also flowing into artificial intelligence, digital health and cyber-security (see chart).
The recipients of investors’ largesse are also getting more global. Although American and Chinese startups continue to top the fundraising league tables, the share from outside the two biggest markets grew from around 25% in 2016 to 40% in the past quarter. In July Flipkart, an Indian e-commerce firm, raised $3.6bn in a round that valued it at $38bn. Grab, vying to be South-East Asia’s answer to China’s super-apps, hopes to go public in New York this year at a valuation of $40bn.
The torrent of cash can be explained by two factors. The first is a divestment spree by the startups’ early venture-capital (VC) backers. These stakes command top dollar from investors desperate for exposure to the pandemic-era digitisation wave. Exits, via public listings and acquisitions, more than doubled globally year on year, to nearly 3,000. The proceeds are flowing back into new VC funds, which have so far this year raised $74bn in America alone, nearing the record $81bn in 2020 in half the time. The venture capitalists cannot spend the dough fast enough. In the three months to June Tiger Global, a particularly aggressive New York investment firm, made 1.3 deals on average every business day.
The second reason for soaring valuations is more competition among investors. Relative newcomers to tech-investing, such as pension funds, sovereign-wealth funds and family offices, are encroaching on the private markets that used to be dominated by VC firms from Sand Hill Road in Palo Alto. In the past quarter “non-traditional” investors in America took part in nearly 1,800 deals that together raised $57bn. Many may have been encouraged by the success of earlier forays by dabblers from outside the VC world. Their annual returns from exited investments in a first round of financing have averaged 30% in the past decade, reckons PitchBook, another data firm. That is more than double the 10-15% for veteran VCs.
This winning streak may yet end in tears. That is what happened two years ago, when richly valued firms with shaky business models either fizzled after their initial public offerings (like Uber and Lyft, two ride-hailing rivals) or never got that far (WeWork, an office-rental firm whose flotation was shelved after investors got cold feet). Many recently listed unicorns continue to bleed cash. According to The Economist’s calculations, those that went public in 2021 made a combined loss of $25bn in their latest financial year.
Assessing whether the remaining ones are worth their lofty valuations looks harder than ever. Like their predecessors, they do not disclose financial results. At the same time, extrapolating from the earlier unicorns, which tended to pursue growth at all costs in winner-takes-all markets, offers little help because today’s lot often aim to capture good margins by selling genuinely unique technology. This could be a more sustainable strategy—if the technology works. But it is harder for non-experts to evaluate, especially based on what is often little more than a prototype. Nikola and Lordstown, two electric-vehicle companies that listed in 2020 via reverse mergers with special-purpose acquisition companies (SPACs), are under investigation by American authorities over allegedly exaggerating the viability of their technology.
Another risk comes from politics. Authorities around the world are growing warier of letting tech firms get too big or entering regulated markets such as finance or health care. As part of a broader crackdown against big tech firms China’s government recently sabotaged the operations of Didi, by banning its app from Chinese app stores days after the firm’s $68bn initial public offering in New York, ostensibly over misuse of users’ data. Such moves have chilled investors’ appetite for Chinese startups, funding for which has actually declined in the past two quarters. In America the Securities and Exchange Commission is beginning to scrutinise the use of cryptocurrencies. Many crypto-exchanges set investors’ pulses racing in last year’s bitcoin rush. Now the market capitalisation of Coinbase, one of the biggest, has shrunk by half, or $56bn, since peaking after its listing in April.
Investors, then, had better beware. For everyone else, the unicorn stampede is a boon. Because venture investments involve mostly equity and little debt, even flops such as WeWork or cautionary tales like Didi pose little risk to the financial system. So long as venture capital is bankrolling lossmaking startups while they offer subsidised services or develop clever new products, consumers have no reason to look the gift horned horse in the mouth.
This article appeared in the Business section of the print edition under the headline “Unicornucopia”