Why billion dollar unicorns are becoming even rarer

2019 is the Year of the Unicorn IPO. You might have seen this phrase thrown around a lot, but what does it actually mean? And why are they becoming even rarer in the US market?

A startup hits unicorn status when it’s valued at USD $1 billion. These companies grab investors’ attention for obvious reasons – they’re novel ideas and they look like they’re performing incredibly well. However, based on the trend of 2019, unicorns are often overvalued. During the IPO process, their value plummets.

The most recent case was WeWork. Pre-IPO, it was worth $45 billion. Then it became clear that there were some dodgy dealings going on. WeWork didn’t go ahead with its IPOs and its value hit rock bottom. Last week, SoftBank bailed it out, taking over 80% of the company.

Business 101 can be summed up in one simple question: Is the value provided by a customer higher than the cost of getting that customer? This is called unit economics and the answer can only be ‘yes’ or ‘no’. With unicorn IPOs, it is often the latter.

Here’s an example of unit economics in a made-up company. Say you keep seeing ads on your social channels for a wine subscription company called Inebriati. Then you start hearing ads for it on your favourite podcast. Inebriati delivers six bottles of really good wine to your door for just $50 a month. A real steal, huh?

But hold on – that initial $50 was a discounted price. The usual monthly subscription is $100. It’s still affordable, so you try it out. The wine piles up. You’re running out of space. You realise it’s not THAT much cheaper than if you just bought the wine you actually love from the store. Two months later, you cancel the subscription. You spent $250 on 12 nice bottles of wine and learnt a bit about wine along the way. It was a good deal.

But Inebriati spent $500 on acquiring you – only to lose you before breaking even. They do it all again with a new customer. The wheel of perpetual loss spins faster.

On the surface, this cycle looks like they’ve got solid customer acquisition. Look a little closer? Their business model is incapable of profit.

This model is rife among unicorn startups. As Derek Thompson so aptly wrote in the Atlantic, “If you wake up on a Casper mattress, work out with a Peloton before breakfast, Uber to your desk at a WeWork, order DoorDash for lunch, take a Lyft home, and get dinner through Postmates, you’ve interacted with seven companies that will collectively lose nearly $14 billion this year.”

Despite the problematic models, the high value and novel concepts of unicorns capture the imagination of investors. They bankroll ventures that burn money faster than you can say ‘red flag’.

Recent trends do not mean new IPOs are a lost cause. Many unicorn companies perform well. Cloudflare underwent an IPO this year and they’ve kept up their 81% gross margins.

They simply suggest that IPO valuations are not always the best measure of success. Long-term profitability is better measured through solid margins and a proven customer base.