Do tech unicorns really matter?

Are tech unicorns really a marker of success? Or merely a symptom of a massively overhyped tech start-up ecosystem on the brink of collapse?

They're called tech unicorns because they are supposed to be rare, the elite of the start-up scene reaching that ultimate milestone of $1 billion in value or more. Yet the number is growing and that magical figure seems less rare, and more run of the mill now. In 2015, there were over 130 tech unicorns; now, according to CB Insights, there are close to 400, and the figure is set to rise.

This spate of billion dollar valuations, for some, is emblematic of a return to the kind of tech boom bubble that ultimately imploded into the dot-com bust in the early 2000s. Keith Wright, instructor of accounting and information services at the Villanova School of Business, predicted in an opinion piece for CNBC that "higher interest rates and the return of market volatility may usher in the end of this tech bubble."

So are tech unicorns really a marker of success? Or merely a symptom of a massively overhyped tech start-up ecosystem on the brink of collapse?

A leg up but not a guarantee of success

Kevin Bianchi, Assurance Partner at BDO, explains that when the term ‘unicorn' was coined by Aileen Lee back in 2013 to describe private startups valued at over $1 billion, just 39 of them existed. But, he adds, the fact that there are more unicorns today doesn't mean the path to get there has gotten any easier or that a $1 billion valuation is insignificant.

"The spike in tech unicorns can largely be attributed to the influx of startups that were born as the economy rebounded from the 2008 recession. Many of these companies are just now reaching the massive valuations that we've been seeing," he says. "Being a unicorn tech company in 2019 is a notable achievement - the percentage of startups that achieve this is still staggeringly low - but a $1+ billion valuation doesn't automatically spell success."

Nick Mehta, CEO of Gainsight, says it's important to understand what a billion-dollar private valuation implies. "Private investors typically buy preferred stock which allows them to get back either the amount they put in or their share of the company - whichever is higher. So there is downside protection. This means preferred valuations reflect potential value more so than public valuations do." 

Anurag Chandra, Venture Partner at Fort Ross Ventures, says: "We have seen plenty of fallen unicorns to know that the hype often gets ahead of a given unicorn's ability to demonstrate a sound business model."

The so-called first "dead unicorn", Evernote, failed to achieve growth despite the attention it received and never really realised its promise in the way investors hoped. Other failed unicorns like blood testing company Theranos failed to deliver on promises its tech couldn't keep - and ultimately ended up with the founder, Elizabeth Holmes, and president and COO, Ramesh "Sunny" Balwani facing charges of wire fraud.

Bianchi explains that while a $1 billion valuation is attractive and highly sought after, maintaining that value is something far more valuable and vastly more difficult. He says it requires laying a solid foundation while on the path to unicorn status - hiring the right leaders, making the right decisions at the executive level, and perhaps most importantly, listening to the consumer.

"Since the technology lifecycle continues to shorten, executives at startups should be ready to adapt. The product or offering that got you to unicorn status may not be the same as the one that sustains the business in the long run," he adds.

A savvy approach is needed

Chandra emphasises that, typically, unicorn status comes with a big round of financing. "If you've demonstrated growth, but don't yet have solid business model metrics you now have the resources to do so. Moreover, you often buy yourself a longer runway to prove your business model and weather macroeconomic challenges," he says.

He also believes that being the "first to unicorn" status in a company's space gives that company an opportunity to freeze out investment for competitors, by leveraging the perception that they have already won the category because it will be too expensive for competitors to play catch-up. 

Manny Medina, CEO of Outreach, itself a tech unicorn, says being a B2B tech unicorn is very hard - it comes with a level of scrutiny that companies don't have to deal with until they are public. Outreach raised $114M at a $1.1B valuation earlier this year and currently supports more than 5,000 sales teams and 50,000 reps worldwide. 

"You have to start hitting your numbers with consistency. You have to demonstrate repeatable revenue and product pipeline, and figure out how to maintain that level. Always optimising for your forward-looking cash flow-ability is a good practice to get into," he advises.

In an inflated, money-flushed environment where sovereign funds invest directly into companies, the valuations can get out of hand, Medina believes. "It's not that there's a lot of unicorns; the companies that are deserving of valuations are getting the funding and no one else is. So for every one unicorn, there are 1,000 companies that aren't getting any funding. In the sales engagement space, there were several competitors when we started. Now, half of them are gone and none of the others are unicorns."

Alex Rinke, co-founder and co-CEO of another tech unicorn Celonis, adds: "Despite the big numbers being thrown around, it's clear that rapid growth isn't enough. It's the unicorns that can map a consistent path to profitability that are ultimately destined for long-term success." He encourages prudence from the start.

"At Celonis, we've been profitable since our launch in 2011 - bootstrapping the company for the first few years before later raising two rounds of funding and becoming a unicorn in 2018. At the same time, we've grown at a rate of 5,000% over the past three years, and 200% in the last year. This has been a result of our worldwide expansion - not just in the US. To us, that's what success looks like right now. Achieving a billion-dollar valuation based on speculation may appear exciting, but it's only viable if sustainability has been built from the very beginning," he says.

An even keel and a level head

Bianchi says that unicorn-status should never be the sole aspiration of a startup. While a high valuation is a significant indicator of success, it is not the end-all-and-be-all. "In fact, many believe that the catchy name for startups valued at over $1 billion only serves to romanticise the idea of a high valuation," he says, adding that what businesses should be aspiring towards at any given point is growth - but not at any cost.

"Many investors, particularly later-stage investors, are increasingly focused on the businesses ability to grow their margins at scale. Those that are able to grow both their top line and gross margins will continue to attract investment and will be best poised for success in the long run," Bianchi says.

Investors are often too eager to pump money into start-ups they have already invested in. Daniel Domberger, technology and software expert and Partner at Livingstone, a global M&A advisory firm, says these valuations are largely divorced from underlying financial performance, propped up by liquidation preferences and repeated fundraising rounds in quick succession. "SoftBank in particular is notorious for this, quickly putting more money into companies it has already backed, at higher valuations, in order to record a rapid paper gain on its initial investment - often after only a few months," he says.

There is still value in the title of tech unicorn, though. But while the US might have been the epicentre of the unicorn quake, it is not the only start-up ecosystem to spawn these mythical beasts - and there are cultural differences in how tech unicorns are perceived around the globe.

Culture clash

"The significance of a startup becoming a unicorn company outside of the U.S. is a bit different, largely because of the differences in the environment of which the company generated its valuation in," Bianchi explains. For example, he says, in Europe there are far fewer startups that reach unicorn status every year, largely because of levels of available venture capital are much lower. Since every market has its own dynamics, the idea of unicorn-status represents something entirely different in the European market compared with the Chinese market.

Simon Johnson, General Manager of Freshworks UK, explains: "When you're competing against Silicon Valley companies not just on product but for investment, it's a particularly gratifying  experience for organisations outside of the region to join the prestigious unicorn club." Freshworks became a unicorn in July 2018.

"As the first Indian SaaS company to claim unicorn status, we want to use this standing to help power India into disrupting and creating the next wave of global product companies. While China has led the manufacturing wave, we believe that India can lead the global wave of enterprise digital transformation," Johnson says. Part of this is supporting start-ups in India, with Freshworks founder and CEO Girish Mathrubootham investing in over 50 start-ups and mentoring hundreds of them.

Rinke adds: "While the US remains a key market, in an increasingly global world it's important to look beyond those borders. For example, the UK is Europe's biggest software market, with Silicon Roundabout representing a vital part of the tech ecosystem. Growth in Asia is also skyrocketing - from the expanding markets of China and India to the more technologically advanced nations of Japan and Korea."

So tech unicorns are not done yet, but they do need to be savvy about how they use their valuation to create genuine success. Maybe the problem isn't the valuation itself but the misperception brought on by the nomenclature. As Mehta says: "I yearn for the era when we return the term unicorn to the world of fantasy and children's books!"