The “Unicorns” Internet Companies Love to Talk Up Look Shakier by the Day — Even to the American Who Coined the Term | What Is Silicon Valley Anxious About❷

In one investor's words, “Too many companies burn $300–500 million to bring in $30–40 million in annual revenue.”

Unicorn: a mythical animal with the body of a white horse, the thighs of a stag, the tail of a lion, and a single horn growing out of its forehead.

Merriam-Webster's Dictionary

Over the past three years, the word has taken on a new meaning.

A 2013 post by the well-known Silicon Valley investor Aileen Lee, “Welcome to the Unicorn Club,” made “unicorn” shorthand for the billion-dollar startup: companies that began with nothing and were worth more than $1 billion before they ever went public. The one-tap car-hailing app Uber, the home-sharing company Airbnb, and, in China, Xiaomi are all textbook unicorns.

The word caught on fast in China too. LeSports, only recently spun off, and Liepin, freshly funded, both used “unicorn” to advertise their own strength.

Beijing TV even made a reality show called I Am a Unicorn, cooking up marvels like “girl born in '98 founds an e-commerce platform, raises 15 million yuan in five minutes.”

But after the same frenzy ran its course, the past few months have brought second thoughts about the “unicorn” model in Silicon Valley, where the word was born.

Since the end of 2015, funds including Fidelity, T. Rowe Price, and Morgan Stanley have been marking down the valuations of the unicorns they invested in. Half of the top 15 “unicorns” in the United States have been affected.

Among them, Palantir, WeWork, and Zenefits have all had layoffs or seen employees leave in droves.

The wildest case is the blood-testing company Theranos: after reporters found that its core technology was a fraud, its $9 billion valuation evaporated. Hollywood is already turning the story into a movie.

The great majority of these companies have no Theranos problem. They make the most innovative, the best products in their fields.

But investors no longer believe they are worth that much money.

Where did the idea of using capital to force-grow a tech giant in five years come from?

The man who set off the investment boom of the past few years, and made people endlessly optimistic about how fast tech companies could grow, was Facebook CEO Mark Zuckerberg.

Facebook is regarded as the first unicorn: a company that did not chase profit at the start, but raised enormous sums to capture users and push up its valuation.

Before it went public, Facebook was already the largest social network in the world, valued at more than $100 billion. Plenty of investment firms still doubted it could make money.

Right up to the 2012 listing, Facebook's valuation was cut at one point. The stock fell below its offering price on the second day of trading, and the deal was once called the worst American IPO in a decade.

Two years after the listing, Facebook's results showed the market had misjudged it: ad revenue grew sharply, and more than a billion people used it every day. Its market cap passed $300 billion early this year, on a level with Microsoft and Amazon.

Facebook's success turned the investors who had missed it into optimists. Surely, if a company is the best in an important field and holds a huge number of users, it can always support a valuation of tens of billions, even $100 billion?

That is why, after 2013, companies valued at more than $1 billion sprang up like bamboo shoots after rain:

Terrified of missing the next Facebook, investors chased the first- and second-place company in every vertical. These companies might not be making money yet, or might still be in the early work of building a market, but investors were happy to throw money at them to speed things up.

“Raising the next round just means writing down a valuation higher than the last one on a piece of paper, putting together a slide deck, settling on a price, and watching millions or tens of millions of dollars flow into your bank account.”

That is how Uber's early investor Bill Gurley once mocked the funding wave of two years ago.

To be fair, it was this rush of capital that gave a new kind of product the chance to spread quickly.

If Didi and Kuaidi had not spent hundreds of millions of yuan a month on their “taxi war,” backed by their investors, it would be hard to imagine hailing a car with a phone becoming ordinary in hundreds of Chinese cities, large and small.

If Uber and Didi had not fought their rock-bottom price war over premium car service, it would be hard to imagine car-hailing apps in China taking on the taxi business head-on, or regulators even starting to consider adapting rather than banning them outright.

Concentrated capital changed quite a few markets outright.

But not every market the money went into paid off

Dropbox, which built its business on cloud storage, is one such case.

From its 2008 launch to more than ten million users in 2011, Dropbox made the simplest, most usable cloud drive in the world, and even turned down a nine-figure acquisition offer from Steve Jobs. By 2013 the company was valued at $4 billion.

But “cloud drive” alone could hardly bring in revenue to match. So Dropbox CEO Drew Houston drew up a new business plan meant to turn the company into a basic internet service. In the optimistic investment climate of the time, this untested “blueprint for the future” won him a new round of money, and Dropbox's valuation shot up to $10 billion.

After the round, Dropbox bought 13 startups in little more than a year and launched new features: photo management, collaboration tools, a note-taking service.

In that same stretch, before Dropbox had earned a single cent, it spent $100,000 on a 1.5-meter chrome panda sculpture and put it outside the office.

It was burning cash too fast. Less than a year into the glory, Dropbox began shutting down the services it had bought, one after another.

In October 2015 BlackRock, a Dropbox investor, cut the valuation of its stake by 24%. Soon after, another investor, Fidelity Investments, cut the value of its Dropbox holding by 20%.

The unicorns in trouble have mostly hit the same wall

The chrome panda is now Dropbox's pillar of shame.

“The point of the panda is to remind us that we got this one wrong. If you're building a healthy, sustainable business, every dollar matters,” Dropbox told its staff in an internal email this May.

To get through this stretch when it can neither raise money nor go public, Dropbox has also been trimming perks like free meals, the gym, and laundry service.

Google spent freely in its early years too. The free meals and gyms at internet companies are all imitations of the search giant, and in 2008 Google rented out Disneyland in Los Angeles for its annual staff ski event.

If Dropbox could deliver billions of dollars of profit a quarter, the way Google does today, nobody would care about a $100,000 panda.

The problem is that after spending its way to 500 million users and launching a pile of new services, Dropbox still has not found a way to make money the way Google does.

Palantir, Pinterest, and Zenefits are no different. Like Dropbox, each made the best product in its field and traded heavy funding for fast growth, reaching user numbers that stand comparison with giants like Google — and each simply cannot earn revenue to match its valuation.

The market has already responded to the unicorn problem

The first to see the unicorn problem were the investors themselves.

Since last October, a number of American mutual funds have been marking down the value of the unicorn shares they hold:

• Fidelity Investments cut the value of its holdings in the cloud storage company Dropbox, the human-resources company Zenefits, and the enterprise software company Cloudera;
• Morgan Stanley cut the value of its holdings in Dropbox, the big-data company Palantir, and the Indian e-commerce company Flipkart;
• the Hartford Growth Opportunities Fund cut the value of its stake in the image-sharing app Pinterest;
• T. Rowe Price cut the value of its Evernote stake.

These are all investment managers. Marking down the startups they hold does them no good; they are only admitting a reality they have to admit.

The reason is that the unicorns that had already gone public saw their share prices fall hard.

By Fortune magazine's count, the tech companies that went public in the United States in 2015 earned an average of minus $9 million.

The market waited for their results in the hope of finding the next Facebook. Now it is harder for startups that cannot make money but carry very high valuations to cash out by going public.

Silicon Valley has begun to adjust

“In the past the way to cash out that everyone accepted was going public. What we've been seeing lately is that the stock crashes after the IPO and you lose money instead. For small and mid-sized companies, the other way to cash out is mergers and acquisitions,” Jason Gordon, a San Francisco lawyer who specializes in legal advice for tech companies, told QDaily.

Over the past year more of Gordon's cases have involved acquisitions and mergers. He has been running a lot of small events around San Francisco, mostly on the theme of “how to get ready to be acquired,” teaching founders the basics of an acquisition deal. Nearly every one has been packed.

And what about the unicorns valued at billions or even tens of billions of dollars, which are not easy to acquire?

In April the well-known Silicon Valley investor Bill Gurley, an early backer of Uber, wrote a piece on the unicorn problem that traveled far through Silicon Valley's startup investment circles. His answer: more funding only brings more trouble. Stop thinking about expanding on raised money; cut the valuation and cut spending if you have to, but get the company's profits working first.

Cutting your own valuation is not as easy as it sounds. Many people gave up jobs at Google or Facebook and joined fast-growing startups precisely because they expected their share of the options to turn into real money once the company went public or was bought.

A lower valuation means their income shrinks, at least in the short term, with no guarantee it will climb back. That speeds up turnover, which is bad news for a company still looking for a way to make money.

Palantir, Silicon Valley's big-data unicorn, has suffered plenty from valuation cuts this year. The big-data company, which originally worked for the U.S. government, reached a valuation of $20 billion and at one point ranked second in the country. Last year Palantir began expanding into a new line of work: business consulting for companies.

A year on, the $1.7 billion in revenue Palantir expected never materialized, and it was still losing money last year. In March, Morgan Stanley cut Palantir's valuation by 32%.

Soon employees put up a poster with this “bloody” image in Palantir's office, warning colleagues that everyone's options were about to be worth nothing:

Then came the news of core staff walking out. This company of only 1,500 people lost more than 100 employees in a short stretch, including a good number of executives. In the end Palantir had to announce a 20% raise for anyone who had been there more than 18 months in order to slow the exodus — which pushed its costs up further.

Not every unicorn is unhealthy; some may yet turn into the next Facebook. But most of them show no sign of it now.

The unicorn problem will not stay in Silicon Valley

Bill Gurley set out five symptoms of the unicorn company's problem:

• Cash burns at an extremely high rate;
• Most of the companies are far from profitable;
• Their competitiveness runs mainly on capital;
• They cannot deliver returns to employees or investors in the short term;
• They are eager for the next round of funding.

Hold that list against China's internet companies and you will not have trouble finding every item on it.

Editor's note: PC, the internet, the smartphone… the spread of every basic technology has come with years of fast growth. For the tech industry, that growth has now run for forty years.

It may now pause for a while: the growth the smartphone brought has already slowed, and since car-hailing and food delivery we have seen no breakthrough on the order of social networking or e-commerce, the kind that moves hundreds of billions in wealth.

What new technology will clear the way for the industry's next round of growth? And will it arrive in time?

These questions will affect everyone, from giants like Apple and Google to venture capital firms and startups to every user of every tech product — basically everyone.

Over the past forty years, most of the technology that laid the foundation for the tech industry's continuing prosperity came out of Silicon Valley. We are running a series of reports from Silicon Valley, looking at this change from different angles. This is the second.