There are a lot of people in Silicon Valley and New York betting on “unicorns” – the new breed of tech startups like Uber, Square, Airbnb and Snapchat that have been valued at least $1bn.
Not since the last dotcom boom has so much money been poured into so many hyped companies. As startup founders and their investors hope to turn their paper unicorn fortunes into cold hard cash, some of Silicon Valley’s most successful investors are warning a reckoning is coming. And on Wedneday that magical thinking faces one of its biggest tests.
Square, the mobile payments platform co-founded by Twitter’s Jack Dorsey, will sell shares in New York at a $4bn valuation. A year ago, private investors valued Square at $6bn. Now questions are being asked about whether Dorsey can really juggle his duties at troubled Twitter and a once hot startup that has yet to show any signs of making a profit. If Monday’s initial public offering (IPO) goes badly, a lot of other profitless unicorns will start feeling the chill.
One big problem for the unicorns is that there are simply too many of them. When the term was coined by venture capitalist Aileen Lee in 2013, unicorn was the perfect way to encapsulate something rare, magical and mythical: in this case, a $1bn startup.
But analysts and investors say the version 2.0 tech bubble has inflated so much that the term unicorn no longer fits. So much private money (increasingly from established institutional investors, which previously steered clear of such risky investments) has been pumping into tech firms that $1bn startups are no longer rare, magical or mythical, and it could mean that the tech bubble is about to burst again. “I do think you’ll see some dead unicorns this year,” Bill Gurley, a partner at Silicon Valley venture capital firm Benchmark, has said.
Another VC, Todd Dagres of Spark Capital in Boston, said: “If you wake up in a room full of unicorns, you are dreaming and you can’t expect the dream to continue.”
In November 2013, only 39 tech startups had been worth $1bn pre-flotation in the past decade (Google and Amazon were worth nowhere near $1bn before their IPOs). Today there are 82 $1bn pre-IPO startups in the US and a total of 125 worldwide, according to an analysis by the Wall Street Journal. The combined valuation of all US unicorns is $486bn – more than the annual gross domestic product (GDP) of Austria, Colombia or South Africa – and not one has made any profit, as they are all concentrated on aggressively spending to expand their reach and thereby increase their valuation before floatation.
There are so many unicorns that Silicon Valley needs a new term to describe the most successful new firms: the decacorn, a made-up word for a startup worth more than $10bn. There are still quite a few of these. Uber this summer was valued at $51bn (£33.4bn) (that’s almost four times as much as Marks & Spencer is worth); Airbnb attracted $2.5bn more investment in June that valued it at $25.5bn (£16.8bn); and Snapchat’s latest funding round valued the disappearing-photo app at $16bn (£10.5bn).
There is a growing unease among investors that few, if any, of these companies are really worth the valuations they have attracted, which would make the tech bubble burst as it did at the turn of the century.
Attention this week turned to Snapchat when established mutual fund Fidelity wrote down the value of its investment in the four-year-old company, which is used by more than 100m people a day, by 25%. Fidelity has also written down its stake in Dropbox, the cloud storage company, by 31%, and the company has quietly dropped its IPO plans. In 2014 it was valued at $10bn, but its bankers have warned it will struggle to attract anywhere near that on the public market.
Eyes are now turning towards Square – a payment system that allows anyone to take credit payments via a card reader attached to an iPad – which has announced its plans to float in New York. But it won’t be a celebratory moment for all investors.
Square, which gave potential investors a square-shaped 250-page prospectus over lunch in Manhattan’s chic Midtown Loft & Terrace this week, is also facing questions over the abilities of Dorsey. His other company, Twitter is failing to match Wall Street’s expectations on revenue or profits, and user growth has all but dried up with new users increasing by just 1.3% in its latest quarter. The company’s shares, which peaked at $69 in January 2014, were changing hands for $26 on Friday – the exact value they were floated at in November 2013. Dorsey, 38, is currently juggling the CEO role of both companies.
Many feel Square’s IPO could, in hindsight, be seen as the trigger that burst the 2.0 tech bubble, that it could wipe billions off the values of the biggest beasts such as Uber that are hoping to follow it down the IPO path.
Ominously, as the company announced the price range its former chief operating officer Keith Rabois tweeted: “The steroid era of start-ups is over.”
“I think Square is the beginning of the end of the tech bubble,” Sam Hamadeh, founder and chief executive of financial research firm PrivCo, said. “In terms of the number of unicorns, I have never seen anything like it in 25 years.
“With Square, not only is it the first one where investors are being asked to take a haircut going into it, but I think it will get worse. What already sounds horrible will go on to be terrible.”
Hamadeh said he expects some of Square’s early investors will lose out on their original investments, while late-stage investors have been guaranteed at least a 20% return on the $15.46 they paid last year on the IPO. The company has promised to issue new shares to pay for that return if the shares don’t achieve it in the flotation.
He said investors are prepared to accept a loss, as they have “come to the realisation that ‘yes, we overpaid’”.
“It’s not just Square – a lot of these unicorn funding rounds have been massively overpaid. It is because there has been a disproportionately large amount of investment from established firms that did not invest in startups five years ago, but have gotten into it because they feel they have been missing out,” he said. “But they will be the biggest losers. In our opinion, they have no business being in this space; they will look back and say ‘That was insane’, and the date everyone starts to realise that will be the date of Square’s IPO.”
Alan Patrick, co-founder of technology consultancy Broadsight, agreed that there has been too much “irrational enthusiasm” for investing in startups, and it is unlikely to be matched by what the market is prepared to pay at IPOs. “The private market has been driving these valuations to extraordinary levels, and as they approach the public market the smart money is starting look at it and go ‘oh no, no, no’.
“The number of unicorns is a sign that there is a bubble in the private market – in the dotcom era there were 10 or something, now there are too many to count,” he said. “That for me is a sign that these values are untested and out of step with reality. And none of them are making money, they are all buying revenue with huge war chests.”
Patrick reckoned the 2.0 tech bubble will come to be defined by the unicorn. “Whether it’s the ‘big swinging dick’ of the last one [the build-up to the financial crisis], there is alway a name that attached to a bubble; for this one it will be the unicorn.”
But he added that he doesn’t think the bubble is about to burst just yet. For that to happen, he said, there needs to be an “insanity event” – “something that in hindsight is so extraordinarily crazy, but looked normal at time”.
“Last time it was AOL-Time Warner [a $165bn takeover]. It’ll be an event when everyone goes, ‘Oh my god, that was nuts’,” he said. “That’s what I’m waiting for, and when that happens you blow the whistle.”