Nearly a decade after the term "unicorn" was coined, venture capital's best and brightest companies may have finally outgrown what the ecosystem can sustain. Their rise was a product of business models that engineered growth with cheap money, and the financial conditions that made this model possible have changed profoundly.
Starting in 2021 and continuing for much of this year, the top 10% of US startups could reliably expect a unicorn valuation. Not anymore. The rate at which new unicorns are being formed globally has dropped precipitously after a truly exceptional 2021, in which 584 VC-backed companies secured a valuation of $1 billion or more.
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Flush with cash from recent boom times, unicorns have avoided down rounds and are extending financial runways by cutting costs. Serious damage has been limited to a small handful of companies, but Klarna's 85% valuation haircut earlier this year showed how tenuous these former valuations can be. For now, these companies are in a kind of limbo, increasingly shunned by the crossover investors they rely on for cash and unable to access public markets.
A new suite of indexes from PitchBook and Morningstar captures how resilient unicorns have been, but all signs point to a coming reckoning. The population of unicorns, which symbolizes a fantasy of perpetual growth, may soon shrink. A tale of two cities Globally there are more than 1,200 unicorns with a combined valuation of $4.2 trillion, propped up by a class of specialized investors.
The Morningstar PitchBook Global Unicorn Indexes dynamically track trends in this segment using a mark-to-model approach, which allows daily pricing that factors in both private valuations and comparable public stock prices.
This year, as stocks have tanked, the global unicorn index has declined just 4.6%. Positive indicators in the unicorn indexes have offset much of the public markets' bad news.
"It's an interesting tale of two cities," said Sanjay Arya, head of innovation at Morningstar Indexes. "There's more than meets the eye."
As equity prices have declined, unicorns haven't come back to market at lower valuations. Many companies entered this market downturn with plenty of cash, and the rise of structured equity in VC deals has enabled some large startups to effectively trade investor protections and control in exchange for a beefier valuation, or avoid repricing altogether.
And while billion-dollar valuations have become more rare, unicorn growth remained robust until the start of the summer, with around 300 such companies formed this year.
High up-rounds have trickled in as well, bolstering 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, up from $74.3 billion in 2021.
But the longer unicorns go without raising a new round, the less weight their prior valuation will carry. The indexes will increasingly revise these supersized valuations to reflect private and public comparable companies. As much as anything, the unicorn indexes highlight how out of step private markets remain with their public marks.
Most unicorns can't realistically go public in this environment. Buying time by cutting costs doesn't solve the fundamental calculus of what the market is willing to pay. In the next six to nine months, we'll finally know what valuations these companies can attract and how those marks will affect VC portfolios. Thinning the herd It's clear that, for 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'll see companies that are forced to come back to market in an unforgiving environment," said Kyle Stanford, a senior 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 of less than $1.2 billion, according to PitchBook data. These companies are at risk of 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 doesn't substantially recover, 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 back from late-stage deals in recent months. Overall VC fund performance turned negative in Q2 for the first time in 5 years, and larger markdowns are expected.
If crossover investors believe that VC returns will remain depressed—and there are better deals to be found elsewhere—their retreat from the sector may prove durable. The effect could be severe. For all their mountains of dry powder, traditional VC firms simply don't have enough money to sustain the valuations of the largest companies.
The unicorn moniker has always been about more than valuations—serving as a tool for marketing and recruitment, as well as bragging rights for founders and investors alike. But during a mania caused by easy monetary policy and tech stock euphoria, billion-dollar companies became commonplace. While it's unlikely that unicorns will ever be rare again, the term may start to mean something again.
Photo illustration by Lukas Gojda/Shutterstock and Jenna O'Malley/PitchBook News
This article originally appeared on PitchBook News