In the world of tech, the ever-swelling stable of unicorns that has been dominating the startup conversation for years is set to be thinned. Unicorns are far more common than their title suggests; according to Fortune, the number of private companies currently valued at $1 billion or more stands at 174. Of that total, a huge 66 can be found in California - the majority in Silicon Valley - with New York and China the other two notable locations. Included in the list are giants like Uber, Airbnb, Snapchat, Pinterest and Buzzfeed, but there are plenty of smaller companies with inflated valuations that are in for a potentially rocky 2016.
The impending disappearances will not come as a shock as venture capitalists and analysts have predicted a downturn for some time. In April, Benchmark Capital’s Bill Gurley wrote an essay confirming what has been a discussion for months - that the unicorn situation is unsustainable. Founders, often without a CFO in their ranks, are regularly unequipped to manage such lofty valuations and the burn rates unfortunately associated with tech startups.
It is the latter that many cite as the likely cause of the downturn in unicorn numbers; just as in the case of their ill-fated dot-com counterparts, burn rates are one of the key reasons these companies fail. Founders and backers know when the money will run out, but raising funds has become significantly more difficult. According to Bill Gates, ‘There is some sorting out that is taking place. It should never be a case of closing your eyes and saying ‘Oh, it’s a tech company, just throw money at it’. That strategy worked for about two years; now you actually have to open your eyes and look at the company.’
Investment has reflected this mentality - According to a PwC/NVCA MoneyTree report, VC funding slowed to $11.3 billion in Q4 2015, down 32% from the previous quarter. The ‘easy money’ for tech unicorns has continued to dry up this year, and burn rates will have to be curbed in any surviving unicorn company. Some companies have cut perks - free food, massages, gym memberships etc. - but it will be the loss of jobs and assets that really signal a business fighting for survival.
For years, companies have been ‘funded at valuations that were far ahead of their fundamental progress as businesses… some of those companies are not actually that great fundamental businesses,’ according to Sequoia’s Alfred Lin, and this creates a problem when the company is made public. Bill Reichert, managing director of Garage Technology Ventures, said: ‘The public markets cannot possibly absorb the current batch of unicorns at their current valuations, not to mention the thundering herd of unicorn wannabes. There will be more disappointment than celebration over the next 18 months.’
Identifying the unicorns most at risk of disappearing is difficult, though. No company goes bust with money in the bank, and private startups are rarely open with their balance sheets - other metrics must be looked at. According to Danielle Morrill, founder of Mattermark (via Business Insider), at-risk unicorns fit the following criteria. They haven’t exited, they have raised over $100 million, they have seen growth in number of employees in the past six months fall to 5% or less and they have raised new funding in the last 36 months.
Unicorns that fit these criteria, as well as having low growth scores, are the most at risk. They have displayed promise but rounds of funding often wildly skew valuations, with employee growth a key giveaway. B2B companies in this situation tend to find buyers - albeit at an often greatly reduced valuation - but B2C unicorns with low margins face a difficult time. Startups that primarily sell to other startups, too, will face difficulty - businesses need to know who their customers are, if only to avoid a shock if some of their key clients fold in the near future.
According to data from Mattermark, analyzed by Business Insider, a number of e-commerce companies could be in trouble, while biotech and energy startups are desperately struggling. The impending decrease in unicorn numbers is not just caused by existing ones struggling, and the slow down in VC funding will compound the issue and see the pool shrink further. What is perhaps important to remember, though, is that this will simply be a return to normality. The bloated valuations of the past few years have been the true anomaly, and many are of the opinion that a return to realistic investment will actually benefit the economy as a whole. Sky-high optimism is just one end of the ebb and flow of Silicon Valley and the wider startup scene - the tech unicorn could be set to rediscover its rarity.