What are Unicorns?

In our day-to-day life, we often use the term unicorn to refer to a mythical horse-like creature. In the year 2013, a venture capital investor named Aileen Lee borrowed the term to describe a particular kind of startup company.

The unicorn term was used to describe the startup companies which were thought to be so rare at the time that they could actually be considered to be mythical. However, ever since, times have changed significantly. Unicorns are now quite common. An average investor or a consumer can now name three-four unicorns that they have heard about.

In this article, we will have a closer look at what a unicorn is and what are the characteristic features which set it apart from other startups.

What is a Unicorn?

The term unicorn is used to describe startup companies that have achieved a valuation of $1 billion or more. This is because companies that command a massive valuation of close to $1 billion are generally expected to be publically listed companies that have been in business for a long time. Startup companies backed by investors which achieve such a high valuation in a short period of time were thought of as being elusive in 2013. Hence, the term “unicorn” was used.

However, of late, a lot of startup companies have been reaching this milestone. There are literally hundreds of unicorns in the global economy today. This has led investors to believe that companies with a $1 billion valuation are not elusive at all! Instead, they want the classification parameters to be changed. Instead of classifying a firm that has a $1 billion valuation as a unicorn, investors want companies that have raised $1 billion in funding to be classified as unicorns since these are the types of firms that can be considered to be truly elusive.

Are Unicorns a Sign of a Financial Bubble?

There are some investors who believe that the existence and proliferation of unicorns is a sign of the increased technological prowess which has been achieved over the past few years. However, there are others who believe that more and more unicorns are coming into existence because of a financial bubble.

The valuation of unicorns is quite subjective. This is because unicorns are companies in the very early stage of their growth. Hence, these companies do not have the financial records or performance which could support a billion-dollar valuation. Instead, many of these companies are not even making a profit and have a negative cash flow.

Their valuation is totally based on the investor perception that these companies have a strong value proposition that their competitors may not be able to imitate. However, this is just perception-based and has no financial backing.

Also, there have been instances where investors have created hype about the startup company, increased its valuation, and perceived brand value only to list it at a high price and exit the investment. There have been cases where individual investors who purchased these stocks on the market have lost a lot of money.

Since the valuation of unicorns is a sophisticated process that is beyond the realm of average investors, the average investors would be better off if they stayed away from these investments until there were enough cash flows and financial data available to conduct a proper valuation.

Why do Unicorns Have High Valuations?

Compared to a regular startup company, the valuation of unicorns tends to be absurdly high. There are certain reasons behind this valuation. These reasons have been listed below:

1. Fast Growth Strategy: Unicorns are companies that have a technological edge over their peers. However, these companies also want to capture the market share as soon as possible since that will help them obtain the first mover’s advantage and also create a brand value. In order to capture market share quickly, these startups need aggressive funding.

   Many venture capital firms are willing to provide this aggressive funding since they believe that the startup will be able to capture a significant portion of the market share. They also believe that high valuations are the only viable method because if they take a slower and more cautious approach, then they may lose market share to the competition.

2. Buyouts: Many times startups have ideas that can potentially disrupt the business of a very large enterprise. The case of Instagram and WhatsApp can be used as cases in point. Both these companies were acquired for a multibillion-dollar valuation by Facebook which saw them as a potential disruption to its business model.

   Larger companies are willing to pay a premium to wipe out the competition and to acquire disruptive technology. Hence, startups that have such technology can command a premium.

3. Scalability: Unicorn companies are much more scalable as compared to their counterparts. This is because the entire business model is based on using massive funding to rapidly scale up the business and obtain market share. The high scalability is often used to justify the high valuation that is attributed to the firm.

The bottom line is that unicorns are a very special type of case. Every investor cannot profit from investing in them. However, it would be unfair to say that all unicorns are a bubble. After all, the big tech giants of today i.e. Facebook, Airbnb, and Twitter were all unicorns not so long ago.