The Evolution of the Corporate Unicorn

Etymology and Definition

Aileen Lee, a venture capitalist, is the person who named the extremely rare and unique startups valued at over one billion dollars “Unicorns.” In 2013, Lee came up with a list of 39 US-based software companies founded in 2003 or later that were valued at over one billion dollars by public or private investors. These companies were considered members of the prestigious “Unicorn Club.” One example of a veteran unicorn is Facebook.

Some of these unicorns are valued at much more than one billion dollars, making them members of the “Decacorn Club” (companies that are valued at over 10 billion dollars – for instance Uber, which is valued at 68 billion dollars and AirBnB valued at 29.3 billion dollars) or the “Hectocorn/Super-Unicorn Club” (companies that are valued at over 100 billion dollars – the earliest one was Intel).

Although it may currently seem that the unicorns are here to stay, some believe that this fantasy bubble is about to burst.

Evolution and Geography

Initially, obtaining the status of a unicorn seemed to be a goal that was out of reach. The desire to be named a unicorn derived from the fact that this status meant a recognition of the company’s force. Yet, founders claim that it also has a practical advantage of helping in hiring and in media visibility.

While still quite outstanding, unicorns are much more common. As of October 2017, there are approximately 215 unicorns all over the world, mainly in the fields of e-commerce, internet software, and fintech, but also in cybersecurity, big data, and healthcare.

The evolution of unicorns and their choice to develop in the private market is a result of the availability of large quantities of private capital. Unlike companies like Amazon and Microsoft that were founded before the year of 2000 and were mostly publicly funded, many high-valued companies of today are funded by private investors.

There is also an ongoing trend toward faster growth in valuation of companies across the world. A study by the Harvard Business Review shows that, in general, startups founded between the years 2012 and 2015 grew in valuation more than twice as fast as companies founded between the years 2000 and 2003. This fast growth is a result of startups adopting strategies such as reducing supply costs by outsourcing some of its functions, price cutting, purchasing rivals, and otherwise pushing away competitors to increase returns. In addition, social media and the access it provides to its users benefit the growth of unicorns.

The United States, specifically California, New York, Massachusetts, and Utah, is the home of most unicorns, while the rest of the unicorns originate mainly in Asia or Europe. However, China, specifically, is narrowing the gap with the United States. As of 2017, approximately 33% of the new unicorns are Chinese companies and 44% of the overall capital is invested in these Chinese companies. It is likely that in the near future China will narrow the gap even more, as it takes Chinese companies, on average, four years to reach one billion dollar valuation, while it takes American companies, on average, seven years.

Extinction Risk

Despite their growth and continued geographical spread in recent years, there are several reasons that unicorns may cease to exist in the future, including:

1. Inaccurate valuation

The valuation of unicorns, as well as any other startup company, is based on the most recent funding round rather than the actual amount raised. Namely, the valuation is less accurate because it is not subject to public scrutiny, yet it is supposed to reflect the best approximation of value creation. Some articles suggest that this valuation reflects the founders’ hopes, the pace of growth of the corporation, investors’ self-protection, and the investors’ fear of missing out on the “next big thing." This valuation may fluctuate based on the company’s performance and other external factors that may affect either the entire market or the specific sector.

Inaccurate valuation may also affect the unicorn’s employees and put them at risk. While investors are protected in cases of liquidation events (IPOs included), by contract provisions, employees who hold shares of the company are usually contractually denied these protections. Therefore, in the event the company’s valuation is lower than expected, employees stand to suffer a significant loss as the value of their shares is much lower than they thought.

2. Lack of business model

There is a concern that some unicorns expand too fast before they develop and prove their business model. Not only are such investments risky as a result of the companies’ business models not being proven, but the companies may also lack the understanding of what is the best way to use the money that is raised.

3. Failure to provide profits

Investors in unicorns usually invest with the hope that in a few years, the company’s worth will be greater, usually through an IPO. In practice, however, unicorns tend to stay private. Staying private became an even greater possibility after the JOBS Act of 2012, which enabled companies to have up to 2,000 investors (instead of 500) before being forced to become a publicly reporting company. Additionally, the availability of large amounts of private capital increases the likelihood of companies staying private. Moreover, unicorns may prefer to avoid the increased regulations that public companies are subject to and the exposure to public valuation that may be different from the value determined by the private investors.

Another reason for staying private for a long time may be the great chance to create more value after the IPO (research shows that companies that go public between the age of six and ten generate 95% of the value created post IPO). On the other hand, staying private for a longer time can result in missing the opportunity to ever go public, as it can be harder for bigger companies to sell shares to the public.

4. General slowdown in the venture industry

In the last two years, investors in the venture industry have become more cautious. This has affected, among other things, the number of unicorns that emerged each year and the number of unicorns that exist.

Notwithstanding the risks inherent to unicorn companies and the general slowdown in the venture industry, some private investors keep funding unicorns all over the world and in a variety of fields. In fact a new kind of unicorn was recently born–the ICO unicorn–which occurs when a company passes the market cap of one billion dollars via an Initial Coin Offering. This fact may suggest that the unicorns that have been an integral part of the startup ecosystem in the last six years are here to stay. However, the bubble still may burst at some point in the future as a result of the above mentioned risks and other challenges that these extremely dynamic industries, may face.

Danielle Kfir (Dulitzky) serves as the graduate editor of the NYU Journal of Law & Business. She is an LLM candidate in Corporation Law. Prior to attending NYU she worked as an associate in the corporate department of Yigal Arnon & Co., one of the leading law firms in Israel, and as a teaching assistant in Property Law and Contract Law in Tel-Aviv University. Danielle graduated from Tel-Aviv University School of Law magna cum laude in 2015.