Is it time to thin out the herd of unicorns?  |  PitchBook

Is it time to thin out the herd of unicorns? | PitchBook

Nearly a decade after the term “unicorn” was coined, perhaps the best and brightest venture capital firms have finally outgrown what the ecosystem can handle. Their rise is the product of business models that generated growth with cheap money, and the financial conditions that made that model possible have changed profoundly.

Starting in 2021 and for much of this year, the top 10% of U.S. startups could reliably expect a unicorn valuation. Not anymore. The rate at which new unicorns are forming around the world fell sharply after a truly exceptional 2021, in which 584 venture capital-backed companies achieved a valuation of $1 billion or more.

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Cash-rich from recent boom times, unicorns have avoided down rounds and are extending financial runs by cutting costs. Serious damage was limited to a small handful of businesses, but Klarna’s 85% valuation discount earlier this year showed how tenuous those old valuations can be. For now, these companies are in a kind of uncertainty, increasingly shunned by the cross-investors they rely on for their cash flow and unable to access public markets.

A new index suite from PitchBook and Morningstar captures how resilient unicorns have been, but all signs point to judgment coming. The unicorn population, which symbolizes a fantasy of perpetual growth, may soon dwindle.

A tale of two cities

Globally, there are over 1,200 unicorns with a combined valuation of $4.2 trillion, backed by a class of specialist investors.

The Morningstar PitchBook Global Unicorn Indices dynamically track trends in this segment using a mark-to-model approach, which enables daily pricing that takes into account both private valuations and comparable public stock prices.

This year, while stocks have tumbled, the Global Unicorn Index is down just 4.6%. Positive indicators from the unicorn indices offset much of the bad news from the public markets.

“It’s an interesting story of two cities,” said Sanjay Arya, chief innovation officer at Morningstar Indexes. “There’s more than meets the eye.”

While stock prices have fallen, unicorns have not reentered the market at lower valuations. Many companies entered this market downturn with plenty of cash, and the rise of structured equity in venture capital transactions has allowed some large startups to effectively trade investor protections and control in exchange for higher valuation, or avoid repricing altogether.

And while billion-dollar valuations have become rarer, unicorn growth remained robust through early summer, with around 300 such companies created this year.

High bulls also crept in, bolstering the companies in the index. Chinese fast fashion company Shein was reportedly valued at $100 billion in April. SpaceX’s valuation jumped to $127 billion in a Series F round in June, from $74.3 billion in 2021.

But the longer the unicorns go without raising a new trick, the less weight their previous rating will have. Indices will increasingly revise these oversized valuations to reflect comparable private and public companies. As much as anything, unicorn indices highlight how private markets remain out of step with their public brands.

Most unicorns cannot realistically be made public in this environment. Saving time by cutting costs does not solve the fundamental calculation of what the market is willing to pay. Over the next six to nine months, we will finally know what valuations these companies can attract and how these ratings will affect venture capital portfolios.

Thinning the herd

Clearly, despite all the bad news in the tech world, we’ve only seen the tip of the iceberg when it comes to unicorns.

“Next year we will see companies forced back into the market in an unforgiving environment,” said Kyle Stanford, principal analyst at PitchBook.

One thing to keep in mind is that most unicorns barely qualify for the designation. About a quarter of global unicorns — 337 companies — have a valuation below $1.2 billion, according to data from PitchBook. These companies risk falling out of the category altogether.

Others will lose their unicorn status because they decide to exit private markets by going public or being acquired. Even if the stock market does not recover materially, these companies may decide that access to public debt markets makes the move worthwhile.

Crossover investors, such as mutual funds and hedge funds, have been a driving force behind the unicorn phenomenon, but many have pulled out of late-stage deals in recent months. The overall performance of venture capital funds turned negative in the second quarter for the first time in 5 years, and higher markdowns are expected.

If crossover investors believe that venture capital returns will remain depressed – and that there are better deals to be found elsewhere – their withdrawal from the sector could prove to be long-lasting. The effect could be serious. For all their mountains of dry powdertraditional venture capitalists simply don’t have enough money to support the valuations of the biggest companies.

The unicorn moniker has always been more than ratings – serving as a marketing and recruiting tool, as well as bragging rights for founders and investors. But during a mania caused by accommodative monetary policy and the tech stock euphoria, billion-dollar companies have become commonplace. While unicorns are unlikely to be rare again, the term may start to mean something again.

Photo illustration by Lukas Gojda/Shutterstock and Jenna O’Malley/PitchBook News

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