Unicorns: Too Good To Be True?

In startup tech language, a “unicorn” is a company valued in the range of billions of dollars, an accomplishment as rare as finding a real unicorn in the woods during a casual weekend hike. A few years ago, the chances of starting a business and this business reaching unicorn status was around 0.00006 percent. It was easier to win the lottery.

But as technology has proven to the venture capital industry to be a money-making machine, there has been a huge increase in investments in high-tech companies, which are the most common type of companies reaching unicorn levels. This increase in investment also attracts the attention of entrepreneurs, creating a virtuous circle: more money is being invested in tech companies, more people are starting tech companies to capture and take advantage of this trend. As the law of numbers suggests, the larger the potential universe, the larger the chances for certain events to happen; in this case, becoming a unicorn.

According to latest data provided by AngeList, a venture-backed seed-stage company has a 2.5 percent chance of becoming a unicorn. That’s a one-in-40 shot, and this trend of increasing chances of becoming a unicorn has been doubling since 2018.

It would be crazy not to start a high-tech company when the chances of becoming a billionaire are so high, but is it too good to be true? What’s the catch? Is this a bubble? Who knows, but let’s be honest, these “billion-dollar” valuations are paper money amid stories inflated by tech media outlets trying to catch readers’ attention. These valuations are based on the potential return if the company’s assets become liquid. They do not, in many cases, mean these companies are making billions of dollars. This is paper money and although it looks good on LinkedIn, it doesn’t help to pay the rent or buy a case of beer unless someone else thinks your tech, product or client base really is worth those billions and is willing to exchange real money for your assets.

This dangerous combination of money available and people’s attention can steer the way the tech industry works, making entrepreneurs shape their company and business model to optimize for fundraising rather than making money. The model of growing at all cost, fueled by VC money, which has worked for some companies even if they are bleeding and swimming in losses, won’t necessarily work for all others. At some point in the economic cycle, the VC money will dry up and the these “unicorns” will need to prove whether their product and business model really are a money-making machine and not just a spending money machine.

Attracting clients when subsidizing the final product and taking a loss is relatively easy. Turning those customers into a profit is hard; harder than the 2.5 percent chance of becoming a unicorn.