I’ve written in the past about my general skepticism around the unicorn craze that seems to have gripped the startup world over the past few years. I argued that focusing on a $1 billion valuation distracted us, and indeed founders themselves, from developing the kind of profitable and sustainable businesses that ultimately benefit society.
Whereas when the term was first coined, there were less than 40 unicorns, there are now reported to be around 2,500 in the wild. The growth in startups with unicorn status is often touted as an example of the rude health of the startup world.
A poor measure
Not only is this supposed disruption not really resulting in incumbents being toppled or productivity marching ahead, but the number of startups able to actually turn a profit is vanishingly small, even among the exulted unicorn club. Instead, the majority remain kept afloat by a regular flow of investment that hides the red ink gushing forth from their P&L statements.
Indeed, analysis from consultancy firm Bain suggests that there are only a handful of firms that have been created over the past 20 years that are actually generating operational profits at any kind of scale.
The researchers argue that judging the supposed success of a startup by its valuation is increasingly meaningful at a time when an influx of VC funding has caused valuations to mushroom. It’s a model that has been largely propped up by a tiny number of incredibly successful businesses, like Amazon and Google, but betrays the vast majority that are hemorrhaging cash left, right, and center.
Generating cash
It’s considerably harder to generate one’s own cash than it is to raise it from investors, yet it’s hard to shake the feeling that too many founders are fixated on pumping up their valuation than they are becoming profitable.
Bain believes that success should be gauged by whether a startup can not only garner a $1 billion valuation but also generate $1 billion in revenue and cash flow. They find, however, that while 2,500 companies have reached unicorn status based on their valuation, less than 250 generated more than $1 billion in revenue, with a paltry 15 generating $1 billion in both cash and revenue.
In other words, just 0.7% of unicorns generate the kind of money that would make them a sustainable and successful business. So often we get obsessed with what startups “might” become that we lose all focus on whether they actually make it or not.
On the way
There are a larger number of companies on their way to this exalted status as they have passed $1 billion in terms of valuation and revenue but not profit. Out of the 206 public companies in this group, some, like Uber and Snowflake, are doing great and seem like they’ll hit the cash flow milestone soon. But a lot of others haven’t moved fast enough to build strong businesses. Meta took just seven years to hit $1 billion in cash flow. Tesla, which needs more capital, took 15 years.
Yet 54% of the companies in this group are over 15 years old and still struggling. Quickness is a big advantage for new companies. Now, the urgent task is to use this advantage to shape business models that bring in cash.
With capital less available, there should be a clear incentive to focus on startups with more appropriate business models, but it’s far from certain that shift in focus has occurred yet. Until then, it’s likely that the awful conversion rate of highly valued startups to startups with robust commercial success will continue.
