Will the Unicorn Boom Lead To a Unicorn Bust?
The current unicorn boom in India is uncannily similar to the events that led up to the dot com fiasco of 1999-2000. Stakeholders must take heed, tread carefully and draw lessons from recent history
The term ‘unicorn’ was coined by US-based venture capitalist Aileen Lee. She was perhaps drawing a parallel with the mythical creature, to try and highlight how valuations of certain billion-dollar startups were perhaps just as mythical -- or based on figments of imagination.
There are currently 817 unicorn start-ups globally, led by China-based Bytedance. Its TikTok offering was 2020’s most downloaded app, with the company now boasting a $140 billion valuation. India, meanwhile, accounts for 68 unicorns, making it the third largest startup ecosystem worldwide. In only the past week, three more companies joined the unicorn club -- namely, Vedantu, Licious and CoinSwitch.
The first key catalyst, fuelling the unicorn boom, is quantitative easing in the US. It has led to strong FDI inflows into India. Second, China’s aggressive stance against several of its large tech companies has been an indirect blessing for Indian startups. Third, Indian conglomerates have also encouraged startup growth. And fourth, the pandemic itself was a contributor to tech uptake, with a corresponding increase in new investors. As one Forbes commentary put it, “India’s unicorn party is just getting started”.
But this isn’t the first unicorn boom catching eyeballs!
Between 1995 and 2000, internet companies were all the rage in the US. Investors were extremely bullish and companies, with an internet involvement, were the ‘darlings’ for both private and institutional investors.
The ensuing dotcom bubble of 1999-2000 stemmed from a highly speculative environment in the US, where low interest rates meant a large availability of venture capital funding. Speculative investing fuelled a 400 percent climb in the Nasdaq Composite stock market index in the 1995-2000 period. Large fundings would enable more extensive marketing campaigns, which would then lead to wider awareness, translating into more users. Some start-ups spent as much as 90 percent of their budgets on advertising.
Many of these still unprofitable internet companies then filed IPOs. Of the 473 US companies that went public in 1999, 280 were tech companies. At their zenith, their combined stock value was a stratospheric USD2.95 trillion in early 2000. Fiscal responsibility was abandoned as the race to get bigger--and at the quickest possible pace--was the overriding mantra. Valuations were determined more by growth potential than by traditional financial measures. In simple terms, there was a sense of over optimism.
Unfortunately, the optimism did not last long. Many listed startups crumbled almost as quickly as they rose. Between March and September 2000, USD1.76 trillion was lost from the decline in tech companies’ stock values. In the years since, only 66 of the 280 survived as independent entities until end-2018. Many merged with larger companies, while 157 of them either collapsed or delisted from exchanges.
Is a similar trend likely to play out in India too? More importantly, is there more than meets the eye?
Expected side effects of this unicorn boom
Competition among investors for a share of the Indian startup pie is driving sky-high valuations that are, quite simply, illogical. An uncannily similar trend is playing out as it did in the US, from 1995-2000. Numerous startups in the Indian technology space have astronomical valuations, with profitability forecasts still way into the future. Only about 30 percent or nine unicorns were EBITDA-positive as of August 2020. Massive marketing spends are still the norm; only this time round, the duopoly of Google and Facebook are the prime beneficiaries. In another similar trend to the US dot-com era, IPOs are being filed by unprofitable Indian startups. There is a similar fiscal irresponsibility on display as was the case two decades ago. A belly-up scenario is possible.
A further direct consequence of the unicorn boom are ‘talent wars’. With demand for tech talent far outpacing supply, there has been a steep surge in remuneration offered. Prior to the pandemic, the increment offered to retain tech talent ranged between 10-12 percent. The current figure is more than double at 25 percent.
Key takeaways for stakeholders from the earlier dot com bubble to lower risks
There is going to be a cooling-off in the unicorn frenzy. Alarm bells, although faint, were sounded when US-based video streaming platform Quibi went bust in October 2020, barely six months after launch. In its brief lifespan, it had raised an enormous USD1.75 billion. Another example was Scalefactor, a startup that offered bookkeeping services for small businesses. Following a funding round that saw its valuation peak at USD360 million, it met with an untimely demise in June 2020.
Amid an uncertain backdrop, with mythical valuations, it is imperative then to examine how caution can be, or is, being taken.
Investors. Institutional investors expect the “vast majority” of unicorns to not last over the longer term, similar to the aftermath of 1999-2000. But they buy into several start-ups simultaneously, helping mitigate risks. Even one or two hugely successful startups can well compensate for losses incurred in other ventures. Japan SoftBank is a clear example in this regard. Besides, the fear of “unicorpses” or dead unicorns might loom large once the strong funds flow from the US ebbs.
Founders. Consistent growth is necessary for any business. But founders must bear in mind that with thousands of jobs on the line in their billion-dollar companies, financial security is more important than ever. A failure in this context will cast a wide ripple effect, not only in the domestic economy, but globally as well. In FY20, aggregate losses among Indian unicorns totalled USD3 billion.
Employees. With company valuations often being overstated, employees realised that, at times, what their ESOPs were said to be worth could be entirely different when they choose to cash in. This was precisely why two finance professors built an online calculator to help their graduate students make better sense of their non-cash offers at “so-called” unicorns.
Consumers. Venture capital funding has ensured lower prices for an array of consumer goods and services. But once regular market forces come into play, the consumer will be left staring at a significantly higher purchase bill for the same basket of items. The Indian fintech sector particularly--where the current frenzy is making cheaper loans available--holds the possibility of throwing thousands of borrowers in jeopardy. Wondering why? Because a near-term increase in interest rates will make these loans difficult to service.
In Joseph Conrad’s 19th century novel called Heart of Darkness, the overriding message was for colonisers in Africa to exercise restraint; that they should not give in to excesses. The equivalent of colonisers today are ‘technocrats’. In what may seem a foreboding of sorts, billionaire investor Stanley Druckenmiller told CNBC in September last year that, “Everybody loves a party… but, inevitably, after a big party, there's a hangover.”
Amit Kumar is a business leader who has built multiple internet consumer businesses in the last decade. He was earlier Managing Director of Kaymu (Merged with Jumia, Listed on NYSE). He likes to write about Leadership, Startups and Economics.