That's What's up with Unicorns

Picture: Archie McPhee on Flickr

Technology industry is significantly fast paced. New lessons are learned everyday, and what could be working well yesterday might not work today. However, besides the lessons learned, there are some patterns in the tech industry that indicate a possible upcoming of a new bubble.

The most notorious bubble burst in 2001, that was called the dot-com bubble. The basis for the problem was in overinvestment. There were expectations that companies heavily relied on the Internet, and companies were offering services to other firms that relied on the Internet, thus, they would be extremely profitable.  However, very few companies managed to meet those expectations. Ebay is one of the firms that managed to stay on the market notwithstanding the bubble (Mark, 2004). Names of some other companies such as Pets.com and Furniture.com are not familiar to many Internet users nowadays, although, lookng back 16 years ago those were highly promising corporations., and they did burst with the bubble. The burst of the bubble seemed to demonstrate investors the problem of putting money into projects without clear monetisation models. As Scott Denne wrote for the Private Equity Analysis, angel investors “have generally grown more savvy and experienced about term-sheet negotiations, due diligence and the broader early-stage investment market (Denne, 2009).   

Fifteen years later,  many believe another bubble in the tech industry is here. This time, it is referred to as the Unicorn Bubble. Unicorns are the companies that have valuations of one billion dollars or higher (Barry, 2015). The term derives from the occurrence of companies like Google and Facebook, that were considered a miracle to an extent, because they could "single-handedly turn a portfolio into a blockbuster, a venture capitalist into a superstar" (Miguel Helft, 2015). The problem and a the reason for a potential bubble lies in the late stage funding. To put it simply, some of the unicorn companies might be significantly overvalued. According to Miguel Helft, one of the good examples is Zenefits. "Zenefits could be the poster child for collective panic", wrote Helft. The company helps businesses to manage Human Resources, payroll and benefits, sells cloud software. But what makes it a "poster child" is its valuation of $4.5 billion, which is 45 higher than projected annual revenue. It might be shocking that a two and a half year old company worth more than Sears and Columbia Sportswear with their joined two centuries of existence (Miguel Helft, 2015).

Another example of a unicorn going bad is Square. Square is a payment system, that goes after credit card companies by offering similar services for a significantly lower amount of money. The company went public in November 2015 with the price of $9 a share at the IPO. However, one year before that, private investors were paying $15 a share. The company lost a large portion of its value. Before going public, the estimate of the company’s worth was $6 billion, however after the IPO it went down to $4 billion (V. Govindarajan, T. Govindarajan, & Stepinski, 2016).  As it was mentioned in the introduction, such companies are usually not considered startups, however, if there are any major events to happen with them, less valued technology companies are likely to be affected as well.

Another reason why unicorns fail to perform well is simply because they are unable to come up with innovations, when competitors match. Even some of the most successful companies, such as Dropbox are under a great danger from the competition. For example, Apple, Google, Microsoft, and Amazon are working in the cloud data management systems now, where Dropbox started. If the unicorn does not develop faster than them, it might lose the battle. Companies in the tech industry need to keep up with the competition, and find out ways how either to improve their products, or diversify them. Sometimes it goes to the extreme, as it was the case with Evernote, that started producing physical goods such as notebooks, backpacks, printers and so on. The company understood the mistake and withdrew from that market (V. Govindarajan, T. Govindarajan, & Stepinski, 2016). In order to be among the leaders in the technology industry, companies should be able to anticipate a change, and be ready to implement that change when needed.

According to Wired's Jessi Hempel if the bubble bursts, it would not be as destructive as the Dot Com bubble, because these tech companies are not publicly owned. Their owners are professional hedge funds and venture capital firms, so they will be the first ones to suffer the hit. However, because people who invest are often acting on behalf of pension funds, university endowments, and wealthy individuals, the economy will feel the effects (Hempel, 2015). Another indicator that the issue is not as toxic as in 2001 is the amount of money entering privately owned technology companies. $48 billion in 2014 is quite modest compared to $71 billion in 1999. Furthermore, when adjusted for inflation, it would be just about one third of the dot-com bubble (Helft, 2015). Nevertheless, the trends with the bubble should be monitored. A potential threat from it to new startups is a potential decrease in valuations and investments. Marketing to investors or pitching in such conditions can be difficult, as they will be even more careful with money they invest. The industry might increase barriers to entry, which although would be challenging for entrepreneurs, might help to create better environment. Environment for startups in general vary depending on geography.