Michael Byers
The emergence of unicorns—startups with valuations of $1 billion or more—reflects a new investment paradigm that believes smaller financing rounds followed by acquisitions or initial public offerings are not the most effective way to achieve success. Late-stage venture rounds have become more frequent and larger, resulting in the creation of billion-dollar startups. As of 2015, there were about 140 unicorns, and that increased to about 340 unicorns in 2018 before it exploded to more than 1,100 in 2021, when the unicorn phenomenon turned into a frenzy. According to Crunchbase, there were 168 unicorns that raised funding rounds of $1 billion or more between 2019 and the first half of 2021.
Since then, the funding environment for startups has become much more difficult. New funding rounds at valuations of $1 billion have become rare, while additional rounds for existing unicorns have often taken place at lower valuations. The real question, however, is how long this dry spell is going to last, as many unicorns have raised enough capital to survive until 2025. It will be interesting to see what happens once these companies, mostly unprofitable, need additional funding—and how many of those startups will maintain their unicorn status or even survive.
Previously, investors were willing to participate in late rounds at high valuations, as the IPO market seemed to offer substantial upside. José Correia and Andreia Dionísio of the University of Évora and Conesa Portugal’s Gonçalo Vidigal analyzed 44 unicorns that went public on Nasdaq and the NYSE between 2013 and 2017. The average pre-IPO valuation of a unicorn was $2.9 billion, and the average IPO valuation was $4 billion, a 35.7 percent increase. Reminiscent of past booms, participating in late-stage rounds and subscribing to IPOs of unicorns was a profitable strategy—as long as the boom lasted.
Participating in the unicorn trend was, and is, also seen by institutional investors as a desirable way to invest in the digital transformation of the economy, as venture-capital funds face oversubscription and restricted access. Recall the 1,100 unicorns in existence in 2021. They had raised a total of $700 billion, with a final valuation of $4 trillion, by the end of that year.
It is unlikely that all of these private unicorns will achieve a large multiple over the money raised. In a famous example of a failed unicorn, the SoftBank Vision Fund made one of its largest bets in WeWork (rebranded as the We Company in 2019) on the belief that flexible office space would disrupt traditional real estate. While the We Company attracted heavy investment as the potential leader in this space, the public market had concerns about the sustainability of WeWork’s unprofitable business model. Having initially aimed for a $49 billion IPO (which it withdrew in 2019), the We Company ultimately went public through a SPAC merger that put its valuation at $9 billion—and was worth less than $5 billion by mid-2022. In November 2023, the company filed for Chapter 11 bankruptcy protection.
Relying on a few investments for outsize returns over a long horizon may not be viable.
The unicorn boom also generated a string of success stories, however. According to Crunchbase, as of 2021, the most valuable private companies globally included ByteDance ($140 billion), SpaceX ($127 billion), SHEIN ($100 billion), Stripe ($95 billion), and Canva/Checkout.com (tied for fifth place at $40 billion).
A series of successful IPOs have shown that unicorns can go public at valuations higher than the amount raised, as well as significantly higher than their post–money valuations from the last private funding round prior to IPO. However, the abundance of unicorns raises doubts about whether this trend can be sustained for the many that are still private. One concern is the issue of “overfunding,” in which entrepreneurs receive excessive funding without sufficient accountability measures. This raises governance concerns for investors, who also believe that it undermines effective cost control and spending discipline.
CB Insights, a business analytics company, published a research report in 2019 that examined the effects of overfunding. To begin with, startups that raised more than $100 million pre-IPO during 2013 to 2018 almost uniformly struggled to reach long-term growth post-IPO and were consistently outperformed by companies that raised less capital. This is an issue for post-IPO shareholders and postmerger SPAC investors.
But there is also evidence that the spread between the IPO valuation and the total funding received was declining. Between 2013 and 2018, those exit-to-raise multiples declined across all ranges.
The creation of unicorns is driven by a fear of missing the next Meta or Amazon. Companies often achieve unicorn status by addressing large numbers of users and providing digitally enabled services previously impossible to construct or deliver—ventures such as Uber, Airbnb, or DoorDash. Informed investors think unicorns are overvalued—regardless of whether they are invested in them, used later rounds as an exit mechanism, or otherwise benefit from the relentless increase in valuations that this stampede of money has caused. Being private, the companies lack liquidity yet have valuations similar to those seen during the dot-com boom. The only way for investors to make a profit is through IPOs or acquisitions made at even higher valuations.
In the past, pre-IPO private placements, which are an alternative to an IPO, were often priced at a 40 percent discount versus the valuation of comparable public companies. However, those “super-rounds” have not shown any valuation discount. By staying private, the funding avoids public-equity market regulations and provides certainty in receiving peak valuation, making it an attractive option for founders and early-round investors. This eliminates the valuation risk inherent in an IPO offering price.
The We Company was once valued at almost $50 billion. But after its planned IPO was canceled due to concerns about its business model and corporate governance, the company went public through a SPAC merger—at a much lower valuation.
Only a small percentage of unicorns are profitable, and their loss-making business models have been called into question by many observers. But the VC industry is well funded. According to PitchBook data, the industry’s cumulative, or undeployed, cash was about $222 billion at the end of 2021, a record high. Tech startups also raised a lot of money—according to Preqin, $476 billion, and CB Insights, $612 billion—in 2021 alone. The Economist reckons that the 70 largest unicorns can cover their burn rates until 2025. This ties in with the fact that secondary pricing for unicorns declined less than the broader stock market. With a shift in investor focus, there was already a slowdown in startups joining the unicorn club in 2022 compared with the previous years, as 308 private startups crossed the threshold in 2022 through November, compared with 596 overall in 2021, according to PitchBook data.
We can expect an increase in acquisitions as investor-backed startups seek consolidation. The reluctance of investors to provide more funding at high valuations will impact unicorns, leading to significant down rounds or failure.
But this process will take time and will only start to gain momentum in a few years. By 2023, the lack of large exits, combined with falling tech valuations and slower startup investment, had made the case for funding a Series D round or later much harder. These factors contributed to pushing US investment at this stage to its lowest point in years. In the first quarter of 2023, total Series D investment was down 92 percent from the peak.
Nontraditional investors, who played a significant role in late-stage funding rounds until 2021 but have experienced significant valuation losses in their portfolios since then, may no longer play the role they once did as providers of capital. Their reduced involvement could impact the availability of capital for unicorns.
In the pursuit of achieving unicorn status and driven by intense competition, startups secured large funding rounds by increasingly granting liquidity preferences to late-stage investors, giving investors in those rounds a choice between a pro rata share in exit proceeds or a preferential repayment of their invested capital. As a result, when unicorns face a cash crunch or consolidation, certain stakeholders may bear the consequences. Earlier-round investors, lacking the protective measures to oppose such concessions, often went along to ensure their portfolio company’s viability in a competitive market. If subsequent funding rounds do not materialize, or the company fails to achieve a favorable exit, late-round investors may recover their investments even if the exit valuation is below the valuation their entry price implied.
Contrary to conventional wisdom, VC investors may thus not be protected by their lower entry valuations and may bear the brunt of such losses. This dynamic challenges the notion that lower entry valuations provide a substantial cushion for early-round VC investors. While a unicorn bubble burst may not pose systemic risk, it could lead to significant write-offs for VC funds and prompt institutional investors to reevaluate their allocations to venture capitalists. Relying on a few investments for outsize returns over a long horizon may not be viable if many holdings are lost and holding periods lengthened. It is uncertain if current stakeholders in unicorns are willing to hold their surviving positions for many years if the risk increases that a significant number of their investments will fail.
Stefan Hepp is adjunct assistant professor of entrepreneurship at Chicago Booth. This is an edited excerpt from his book Private Capital: The Complete Guide to Private Markets Investing. Excerpted with permission from the publisher, Wiley. Copyright 2024 by John Wiley & Sons Ltd. All rights reserved. This book is available wherever books and e-books are sold.
José Correia, Gonçalo Vidigal, and Andreia Dionísio, “Unicorns and Their IPO: Are They Overvalued?” Working paper, August 2021.
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