Nearly a decade after the term “unicorn” was coined, the best and brightest VC firms may have finally outgrown what the ecosystem can sustain. Their rise was the product of business models that designed growth with cheap money, and the financial conditions that made this model possible have changed profoundly.
Starting in 2021 and for much of this year, the top 10% of US startups could expect a unicorn valuation. Not anymore. The rate at which new unicorns are forming globally has fallen precipitously after a truly exceptional 2021, in which 584 VC-backed companies achieved a valuation of $1 billion or more.
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Flush with cash from recent boom times, unicorns have avoided negative rounds and are widening financial runways by cutting costs. Serious damage has been limited to a small handful of companies, but Klarna 85% rating haircut earlier this year showed just how tenuous these earlier valuations can be. For now, these companies are in something of a limbo, increasingly shunned by the cross-investors they depend on for cash and unable to access public markets.
A new set of indices from PitchBook and Morningstar capture just how resilient unicorns have been, but all signs point to a reckoning to come. Symbolizing a fantasy of perpetual growth, the unicorn population could soon dwindle.
A tale of two cities
Globally, there are more than 1,200 unicorns with a combined valuation of $4.2 trillion, backed by a class of specialized investors.
the Morningstar PitchBook Global Unicorn Indices dynamically track trends in this segment using a brand-to-model approach, enabling daily pricing that takes into account both private valuations and comparable public stock prices.
This year, as stocks tumbled, the global unicorn index has declined just 4.6%. Positive indicators in the unicorn indices have offset much of the bad news from the public markets.
“It’s an interesting tale of two cities,” said Sanjay Arya, Morningstar Indexes’ head of innovation. “There is more than meets the eye.”
Since stock prices have declined, unicorns have not returned to the market at lower valuations. Many companies entered this market downturn with plenty of cash, and the structured equity increase in VC deals has allowed some large startups to effectively trade investor protections and control for stronger valuation, or avoid price revisions altogether.
And while billion-dollar valuations have become rarer, unicorn growth remained strong through the start of summer, with around 300 such companies formed this year.
High upside rounds have also trickled in, bolstering companies in the index. Chinese fast fashion company She in It was reportedly valued at $100 billion in April. spacexThe valuation of jumped to $127 billion in a Series F round in June, up from $74.3 billion in 2021.
But the longer the unicorns go without raising a new round, the less weight their previous rating will carry. Indices will increasingly revise these large valuations to reflect comparable private and public companies. More than anything, the unicorn indices highlight just how out of step the private markets remain with their public brands.
Most unicorns cannot realistically be made public in this environment. Buying time by reducing costs does not solve the fundamental calculation of what the market is willing to pay. In the next six to nine months, we will finally know what valuations these companies may attract and how those brands will affect VC portfolios.
Thinning of the herd
It’s clear that 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 will see companies being forced back into the 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 data from PitchBook. These companies risk being left 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 recover substantially, these companies may decide that access to government 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. Overall VC fund performance turned negative in the second quarter for the first time in five years, and further declines are expected.
If cross-investors believe that VC returns will remain low, and that better deals can be found elsewhere, their withdrawal from the sector may prove long-lasting. The effect could be severe. For all its mountains of dry dusttraditional venture capital firms simply don’t have enough money to support the valuations of the largest companies.
The unicorn moniker has always been about more than ratings: it serves as a marketing and recruiting tool, as well as bragging rights for founders and investors alike. But during a mania caused by easy monetary policy and the euphoria of tech stocks, 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