When unicorns become squirrels

squirrel

2015 sure was an interesting year for unicorn VCs. 2016 will be an even more interesting year for the club of unicorns, as they might come face to face with reality and be forced to take on a more humble moniker. All hail the squirrels.

With the systemic corrections on pre-IPO valuations, such as Square, Dropbox and others; it seems to be in the unicorn’s best interest to remain private and avoid to answer the ultimate question altogether: how much does the public think we’re really worth?

Let’s complete that rhetoric.

If you’re employing hundreds of people, demonstrating staggering burn rates, and no sizeable profit to make up for, there is an off chance you might not be perceived as a shiny unicorn by the public, but simply as a company in trouble.

We’re coming back to normalcy where fundamentals matter – David Wadhwani, App Dynamics

For unicorns, IPOs are the new down-rounds. Just ask post-IPO Twitter, Fitbit, Box. And if all else fails, the only thing left to do is to scramble and soft land at a loss, such as the once unicorns Fab or Good Technology did.

Looking for other red flags? Employees at Instacart or Spotify struggle to find secondary buyers for their stock at the last raise. A clear indication how the market is not buying into these crazy valuations.

If you wake up in a room full of unicorns, you are dreaming and you can’t expect the dream to continue – Todd Dagres, Spark Capital

But for once, IPOs and down-rounds might be just the right thing for the unicorns to do. A painful, but just, redemption. A way not to let the bubble burst, but to let it cool down.

This merry band of investors that are stuck on this runaway unicorn train know this all too well.

Fool me once…

Some voice there is even an eerie thin line between the private funding of unicorns and Madoff’s practices. To cut a long story short; as long as fresh money comes in, everybody’s happy.

Everyone knows the party can’t last forever, at some point the music will stop and not everyone will get a chair, but nobody knows how it will end – Anand Sanwal, CB Insights

There is simply not enough bullshit in the world to justify these delusional valuations. But showing any signs of weakness after years of bullish valuations can easily send everyone stampeding for the door.

So these unicorn investors are standing on thin ice, and sudden movements can send everybody down.

Being put between a rock and a hard place, many unicorns will be pushed out of the private market and exposed into the public. They can equally choose to keep the dirty laundry private and accept an ugly exit. Or try and push another raise with valuations and liquidity that feels much like a private IPO.

A nearly six-year-old raging bull market in public stocks has produced a tailwind for private company valuations and convinced the latest crop of tech entrepreneurs that there will be plenty of time to cash in when they feel like it – Erin Griffith, Fortune Magazine in “Age of Unicorns

But another option exist. Perhaps a more realistic one, by privately down rounding to a realistic valuation. Although not a unicorn, but the Foursquare raise is in this case a respectful move that gave the company a new wave of leadership and company credibility.

Fool me twice…

In the last dotcom bubble, investors made big bets on rushing startups to the IPO slaughterhouse where investors got away, relatively clean, but lots of money from unsophisticated retail investors was lost.

Even in this situation, most savvy investors might get away clean again.  This time, however, the victims are the holders of common stock.

The same way the 2000 dot-com crash bankrupted unsophisticated retail investors, a collapse within the 150 or so $1 billion unicorns may wipe out the majority of people who work for those companies, the families they support, the communities they reside in and the businesses who depend on them as customers – Nik Milanovic, Funding Circle

Early employees, founders or people at key positions typically hold common stock, more often without any downside protections. These people pay taxes on the options at the high valuations they are offered, often shelling out a sizeable chunk of their savings, with the probable risk of seeing their company being sold for a lot less.

Worst case, every investor gets to walk away relatively unharmed, except for the people that actually built a company. Well. Sh*t.

When these markets correct, they correct hard. There’s no soft landing in Silicon Valley – Bill Gurley, Benchmark

The problem is that only the people at the top of the food chain know what’s going on in a private company. This often means anyone else has no clue but to relay on the snippets of carefully drafted information that trickles down once in a while.

Anyone that has been dealing with private investors in their business can testify first hand it is often a money, ego and power game, played at a higher level than most team member’s pay grades.

But of course, anyone holding preferred shares walk away clean.

Taking a step back – doesn’t this situation feel a lot like Enron? Where in the end, the employees footed the bill? Perhaps.

But we should also be realistic that in any free market, situations change and investing remains a risky business. Sometimes you’re flush, sometimes you’re bust.

Regulating disclosure

With exuberant amounts of liquidity floating around in the private market, perhaps the private investment market is ready to get regulated.

The bottom line is, most private investors involved in pumping unicorn valuations can’t stand the public scrutiny that comes with running a public company, because it simply ruins the perception management tactics. While some practices are considered illegal when running a public company, in private companies they are often simply frown upon because it’s not regulated.

This would be a good time for the venture capital industry to rethink and set some ground rules that regulate the responsible disclosure of sensitive financial information to the many constituents and key stakeholders of a unicorn, or any fast growing private company for that matter.

Just like the legal definition of obscenity, nobody can describe why we’re in a bubble, but everyone can tell you “I know it when I see it.”

While this practice might be a headache for predatory and opportunistic investors – and founders – a set of simple governance rules might increase the maturity of an entire industry, better prepare private companies to go IPO, and build a more solid economy in general.

I don’t know what’s 2016 is going to give.

Nobody does.

All I know it’s going to be another interesting year for many unicorns, and perhaps we might see decacorns.

Or some might magically transform into another squirrel when they are caught in the headlights of public scrutiny…

 

One Comment on “When unicorns become squirrels

  1. Pingback: 1 – 2016. The year we welcome squirrels – Unicorn Bubble – explodingads

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