Why investors should stop chasing unicorns

The term ‘unicorn’ was first used to describe a category of high-growth company in a 2013 blog post by venture capitalist Aileen Lee. She defined a unicorn quite narrowly as a US-based software company started since 2003 and valued at $1bn+ by public or private market investors. These companies are very rare and very desirable to investors, hence ‘unicorn’. Venture capitalists hunt for start-ups with unicorn potential because they need their many risky investments to return the occasional reward.

Back then, Lee counted 39 unicorns. Today, there are many more – over 1,200, according to the CB Insights definition of private companies valued at $1bn+. Almost half of those are based in the US and a quarter in China.

The mightiest unicorn is TikTok owner ByteDance (China), which is valued at $140bn. There are two other members of the ‘centicorn’ club: SpaceX (US) at $127bn and Shein (China) at $100bn. As well as centicorns, you might hear talk of ‘decacorns’, ‘supercorns’, ‘minicorns’, ‘futurecorns’, ‘soonicorns’, ‘almostcorns’, and even ‘undercorns’ for start-ups which gained and subsequently lost their unicorn status. Journalist Alex Wilhelm proposed an alternative name in a 2019 TechCrunch article: “If a unicorn is a horse with a spike, when you take the spike off, you just have a horse.”

Like it or not, Lee’s blog post shaped start-up discourse for a decade. Unicorns have long since broken out of the start-up pasture, however, and are enjoying being petted and praised by our political leaders. In 2021, the European Commission published its ‘2030 Digital Compass’ plan, which included the ambition of doubling the number of European unicorns by the end of the decade.

Unicorns are irresistible to UK politicians. They seem like a natural element of that (arguably almost mythological) dream of the UK as a ‘science ‘superpower’, to which the world’s greatest inventors and investors come to do business. Both Prime Minister Rishi Sunak and Chancellor Jeremy Hunt recently boasted that the UK has created more unicorns than France and Germany combined – and they are not wrong.

As of December 2022, the UK had created 144 unicorns (according to the definition of companies started since 2000 and valued at $1bn+), giving it the largest unicorn population outside the US and China. In a reflection of the country’s strength in financial services, the UK mostly stands out for its fintech unicorns – especially digital payment services and challenger banks – which now make up around a third of UK unicorns. Most UK unicorns are based in London, although the government frequently points to the appearance of unicorns in other parts of the country, in support of its ‘levelling up’ agenda.

Almost since the moment the concept was named, it has attracted criticism. For a start, nobody quite knows what a unicorn is. While Lee’s definition is generally agreed to be narrow, there is no consistent alternative (three different definitions have already appeared in this feature). There is also the problem that the very characteristics that make a unicorn – ultimately ultra-high, ultra-fast growth – are not necessarily the characteristics of a good business. Unicorns and aspiring unicorns are prone to instability and unethical management, and to collapsing under their own fanciful valuations. Although these intertwined issues may be familiar to many readers, it is worth taking a moment to elaborate.

Many unicorns are consumer-facing companies for which growth relies on acquiring many customers at very low cost, often making a loss in the process. Small changes – whether due to stricter regulations or rises in the cost of capital, labour or commodities – can destabilise a company in this position. This volatility can produce unpleasant environments for employees, rife with layoffs, long working hours and chaotic corporate culture.

Such work environments are far from unusual among unicorns and aspiring unicorns. Uber, for instance, was revealed to have an ‘aggressive, unrestrained’ corporate culture, over which CEO Travis Kalanick was eventually forced to resign. This is just one element of the unethical behaviour to which start-up founders pursuing ultra-high, ultra-fast growth may be more prone. Thanks to Theranos, unscrupulous start-ups have by now become something of a cliché – but unethical behaviour is rarely so brazen.

Many start-ups grow through the resources of their investors rather than through a viable business model, forcing them to raise money continuously to avoid bankruptcy. This could be achieved by honest means, or it could involve a whole spectrum of deception. (It could also involve massive inefficiency as investors seek to capture a market through multiple start-ups competing to acquire customers at the lowest cost possible.) As the gap between value creation and valuation grows, the start-up becomes at greater risk of collapsing under the weight of its overvaluation; an extreme example is WeWork. Today, a growing number of unicorns – especially those in food-delivery and ride-sharing services – appear ever less likely to reach profitability. Were they ever truly worth their staggering valuations?

Dr Andreas Kuckertz, an expert in entrepreneurship at the University of Hohenheim, recently co-wrote a paper criticising the unicorn preoccupation: ‘Chasing mythical creatures – A (not-so-sympathetic) critique of entrepreneurship’s obsession with unicorn startups’. He emphasises that a company’s valuation is not always an accurate indicator of its value. “There are good unicorns that actually create value and the valuation is actually justified. The problem is, I would say, a minor group of investors actually decides whether a certain start-up is a unicorn or not,” says Kuckertz.

“It’s a mechanism that can be gamed and, if unicorns are an ideal we want to achieve or need to achieve, when investors arrive at the valuation of $950m, they could decide: maybe we should somehow tweak the terms a little bit so we can achieve this $1bn threshold because there is value in it itself, it’s good for our marketing. Better a $1bn company than a $950m company. There’s leeway in that and that’s what makes it questionable.”

All this is not to begin to unpack the potential damage to a unicorn’s surroundings: the disruption caused to an industry in the wake of unicorn chases; the diversion of funding and talent from useful but less lucrative ventures. “The best minds of my generation are thinking about how to make people click ads,” data scientist and millennial Jeff Hammerbacher famously said in 2011. “That sucks.”

As someone teaching the next generation of entrepreneurs, Kuckertz is also concerned that the prioritisation of valuation over value creation is creating a distorted picture of entrepreneurship which could discourage bright young people from pursuing social entrepreneurship and other avenues that are worthy but unlikely to lead to unicorns. “The unicorn, once meant to describe a positive outcome of entrepreneurial action, has become a norm for what entrepreneurs should try to achieve,” he and his co-authors wrote.

Although criticism of unicorns is mostly focused on US unicorns, UK unicorns are also prone to volatility, unethical management and doubts regarding their profitability.

Deliveroo has not yet reached profitability and its 2021 listing on the London Stock Exchange was described as “the worst IPO in London’s history” after it lost almost a third of its value in one day. Much-lauded education unicorn Multiverse has posted net losses for six years in a row, with net losses of £14.2m in 2022 up from £10.9m in 2021. It is notable that – despite slick PR operations – many UK unicorns have compromised reputations. Barely a month passes without Brewdog finding itself at the centre of another controversy.

Deliveroo has been repeatedly criticised for the working conditions of its riders. Greensill Capital had its eponymous scandal. OnlyFans, one of the country’s few consumer-facing internet unicorns, has a sleazy reputation (justified or otherwise). The list goes on, and on.
UK unicorns also face a certain complication that their US and Chinese counterparts do not; there is comparatively little local capital available. About half of funding for UK unicorns comes from outside Europe, mostly from US-based investors.

When UK unicorns are acquired, they are frequently acquired by overseas organisations. Zoopla was bought by a US private equity firm, Skyscanner by a Chinese travel agency. Arm – which arguably fits the definition – has been owned by Japanese conglomerate SoftBank since 2016. For this reason, it has been argued that the UK is failing to benefit from the unicorns it creates. Digital Catapult CEO Jeremy Silver strongly criticised the “disastrous” pursuit of unicorns in a recent interview with The Times. Promising UK start-ups are often sold to US investors, he said, which, while good for founders, is not good for the country: “All it’s done is feed our talent to American technology businesses.”

George Windsor, data and research director at Tech Nation, expresses similar concerns in gentler terms. “In some ways, UK unicorns are born on the back of often large-scale investment from overseas,” he says. “The overarching trend is the UK is good at creating unicorns, but for their creation to happen, we often need a bit of an injection from US capital, which is one of the few places in the world where the scale is sufficient to push a company over the billion-dollar mark.” Windsor suggested that the UK should be more “intentional” about helping unicorns manage their exits, whether that involves flotation or acquisition.

For all the very public reckonings around ultra-high, ultra-fast growth start-ups, we are still chasing unicorns. It is hard to resist such a simple and evocative concept – but we should not forget that the concept is primarily of relevance to venture capitalists, and what makes a good unicorn does not necessarily make a good business for everyone else. As the UK weighs up its economic future outside the EU, then, it is worth reconsidering what sort of companies we want to create more of.

Experts advise that we should be looking beyond valuation to judge the success of a start-up. “People have, in some cases, felt a bit jaded with the whole debate around unicorns,” says Windsor. “I think we need a slightly more sophisticated debate to take us forward; to actually think about many more of the characteristics of these companies beyond simply their valuation, which in many cases is speculative and on paper.”

What makes a good start-up if not a $1bn valuation? The potential to solve a problem is the most obvious place to start. Profitability. Durability could also be taken into account (Silver is among the business leaders who have spoken highly of ‘Mittelstand’ companies – mid-sized companies in German-speaking countries with strong community ties and steady, long-term focus). Social benefit could also be considered, although how that could be reliably measured remains an unanswered problem. The organisation Zebras Unite, which argues that civil society has suffered as a result of focus on ultra-high growth companies, makes the case for ‘zebras’: profitable businesses that solve meaningful problems and repair social systems.

The mundane truth of the matter is that there is no singular unicorn-like ideal to which we should all aspire. “Metaphorically speaking, if you want to develop the Great Barrier Reef but only focus on one particular kind of fish, the whole ecosystem is likely to suffer, and then this particular fish that we were focusing on will suffer as well,” says Kuckertz. “We have to focus on all of the species that are part of the ecosystem. In your economy you probably shouldn’t focus on one kind of player but the whole system. Then, if you’re doing the right thing, you may have some unicorns as a by-product.”