The start-up world has a fascination with Unicorns, referring to companies that have achieved a valuation of over $1 billion. As exciting as it may sound, recent studies have shed light on the false rarity of unicorns and the harmful effects of glorifying increasing start-up valuations resulting in a dearth of Zombie Unicorns for whom the future looks bleak. Ultimately this may usher in a cycle of a return to fundamentals and focus on building great companies.
When Did Unicorns Become a Thing in VC?
The term Unicorn was coined by Aileen Lee, founder of Cowboy Ventures and a former Kleiner Perkins partner. She created the term to highlight the rareness of start-ups that could reach a valuation of $1 billion or more. However, according to a recent study by Digital Ocean, there are currently over 750 zombie unicorns and 3800+ unicorns worldwide. The inflated number of unicorn companies diminishes the value of the term and creates a false sense of rarity.
Moreover, the glorification of increasing start-up valuations has led to a distorted view of what success means in the world of entrepreneurship. The focus has shifted from building meaningful businesses based on fundamentals to achieving a desired valuation metric and engineering it at any cost.
This creates a toxic culture where entrepreneurs are judged solely on their ability to sell a dream, rather than the real impact they create. Every founder wants to build a valuable company and no one can say that a company worth a billion dollars isn’t exciting. For those founders who are most motivated by building personal wealth, being the founder of a Unicorn becomes a purpose in itself.
The Rise of the Zombies
We don’t need to look beyond the death of two recent unicorns to see these factors at play. The Founders of both WeWork and Theranos were driven to seeking wealth and success as entrepreneurs first, the business ideas became secondary to their personal pursuits. In both instances, the House of Cards collapsed when the culture of the glorified founder no longer fit reality (the emperor has no clothes) and in the case of Theranos, the truth no longer mattered and Elizabeth Holmes is about to report to prison to carry out her sentence for running a fraud on investors.
The problem with Unicorn Culture is that to achieve these valuations, companies need to price in the future upside potential in the business today. This becomes a self-perpetuating cycle in that investors need to put as much capital as possible to back the “winners” in their portfolios.
Decoupled from reality and fundamentals. In order to justify the value of a company to reach the $1 billion stratosphere it is necessary to include the benefit of future, unrealized outcomes. This means that the investors today are paying for the right to that value in the future. The problem is that even if they deliver on the projected milestones, there is no more headroom in the valuation to see the benefit if and when it comes to happen.
When the music stops, then the truth comes out. When you raise money for the sake of raising money, you run the risk of creating a synthetic (and highly unstable) valuation. This is what we are seeing now, a whole marketplace of Zombie Unicorns where funding was closed, not on what the capital needs of the business were, but for investors who need to show a return. These companies can’t continue to raise the funding they need at higher and higher valuations when capital dries up as is happening in this cycle. They don’t have the working capital to support operating without raising more money, and can’t achieve the desired returns through a public or private exit.
Life Beyond the Zombies
Building a billion-dollar company is possible, and there are a number of deserving companies that have earned that status. These are normally long slow builds, not the wave of new “hits” that investors get so excited about.
In conclusion, the idea of Unicorns and increasing start-up valuations may sound exciting, but it is essential to recognize the harm it imposes on the overall start-up ecosystem. The focus on valuation creates an unhealthy environment where entrepreneurs are incentivized to prioritize short-term gains over sustainable growth. It is time for investors, start-up founders, and the broader community to shift their focus from just the valuation of the businesses to the positive impact they create. By creating a more sustainable start-up ecosystem, we can foster innovation and ensure long-term economic growth.
It is time to reset the Unicorn Culture. We need to go back to building valuable companies rooted in fundamentals and focus on companies that truly create value for their customers, investors, and employees. When a company is built upon the right foundation of sustainable growth, it can build a strong business even without achieving astronomical valuations.
This is the kind of culture that will foster innovation, create long-term economic growth, and deliver economic and personal success for all stakeholders.