In March 2022, near the height of the startup funding frenzy, Forbes estimates that 44 founders of unicorns – private companies valued at over $1 billion – had assets of around $190 billion. A year later, with the collapse of cryptocurrencies and the private markets spelling the end of their public counterparts, Forbes –which consulted leading venture capitals, investors, and data providers – re-evaluated the unicorns backed by the world’s billionaires. The results are stark: half the wealth of the billionaires behind the unicorns has been wiped out, leaving this elite group of visionary startuppers with $96 billion less than a year ago. Twelve of them are no longer billionaires. And that excludes a dozen Chinese unicorn founders facing their own unique set of problems (political and otherwise).

Collapsing valuations

Some unicorns have already reduced their valuations. Online payments startup Checkout.com cut its domestic mark from $40 billion in January 2022 to $11 billion in December, which in turn caused the fortune of its Swiss founder and CEO Guillaume Pousaz, briefly Europe’s richest tech entrepreneur, to plummet to $7.2 billion from $23 billion. Irish payments giant Stripe, founded and run by brothers Patrick and John Collison, has done the same, cutting its valuation on at least three occasions, from $95 billion in March 2021 to $63 billion this month. The brothers now have estimated assets of $6.9 billion each, down from $9.5 billion. Apoorva Mehta’s Instacart and Databricks, Ali Ghodsi’s software startup, also declined in October.

The Swedish buy-now, pay-later startup Klarna, co-founded by former billionaires Victor Jacobsson and Sebastian Siemiatkowski (valued at $600 million and $500 million, respectively – down from $4 billion and $3.2 billion), was revalued at $6.7 billion in July 2022, after it had reached an astonishing valuation of $45.6 billion only nine months earlier. Another example is Gett Taxi, which pioneered ride-hailing apps, reaching a valuation of over a billion dollars. Dave Weiser, who led the company with co-founder Roi More, paved the way for the entire industry, but over the years, they failed to dominate the market, leaving it to Uber, Lyft, and others. Today, the company is estimated to be worth no more than $200 million, with most of its business activity in Israel.

The Unicorn: a myth created by VCs

Let’s start by clarifying the origins and motivations behind the inherent goal of any startup worldwide in recent years: to become a unicorn. Over the past decade, low-interest rates and the stories of success, fame and fortune that have developed in Silicon Valley (Facebook, Uber, Airbnb, etc.) have resulted in billions of dollars, private and public, flowing into venture capital funds created to support the birth and development of high-potential tech companies. Right from the start, it was evident that the only way for most of these funds to make their business model of management fees and carried interest profitable was to define for the companies in which they invested, the achievement of a valuation target of over a billion dollars, then to become a unicorn.

A target determined by the potential return on investment commensurate with the risk. Let’s imagine we have a venture capital fund of $200 million, a normal amount for a fund investing in Series A startups in the US. Assuming the investors (the limited partners, or LPs) seek gross returns (before expenses) of at least 4x the investment – so about $800 million, which, after expenses (and management fees, the costs of the fund), becomes about 3x the invested capital. Considering that investors could quadruple their money simply by buying and holding Nasdaq shares for ten years, with much lower risk, investing in startups makes sense if the investments bring returns in a shorter time, typically between 5 and 7 years. So usually, a fund of this size, which must achieve these returns in a limited time, must make around 30 investments to spread the risk and achieve the desired return.

Economics of the fund

Suppose we assume that the average equity held for companies where the fund decides to invest is 10%, making a straightforward calculation. In that case, it is necessary to reach a total equity value of the portfolio companies (market capitalization) equal to $8 billion for the numbers in the model to work, with an average value of approximately $267 million per company. To these assumptions, however, one must add some determining assumptions, namely that one or two companies will be the ones that will statistically return the most invested capital (due to the distribution of returns – Power Law – according to which a small number of venture capital investments generate the most value) – thus, each company must have the potential to be worth $5 billion or more.

To these ‘economics of the fund’ aspects, another factor must be added concerning the funds’ need to incentivize the chase for unicorns. In fact, VCs are driven to raise ever larger funds, leading to a vicious circle that jeopardizes the sustainable growth of startups, as they are incentivized to do so because they can earn significant management fees while investing and do not necessarily have to wait for the exits of their portfolio companies. Obviously, this mechanism drives them to seek ever-larger investments to maximize profits. As an illustration of this, one observes that in the past five years, the average fund size in Europe has doubled, reflecting this global trend.

Going beyond profit

As funds grow, so does the need to invest in companies that can deliver ever greater returns to investors. This implies that VCs target investments in so-called ‘decacorn’ (valued at $10 billion or more) and ‘centacorn’ (valued at $100 billion or more) companies. This race for high-risk investment means that entrepreneurs, founders of high-potential tech companies, are more likely to make bolder decisions and pursue ambitious goals, very often far removed from reality, to attract this type of capital. In fact, this competitive environment creates a culture that incentivizes founders to take irrational risks and a strong drive to seek the goal of becoming ‘unicorns’. This pressure leads them to inject large amounts of money into the company, encouraging it to spend aggressively and grow at all costs.

So, what should startup founders do in this scenario? The answer might be to resist VC pressure and adopt a more sustainable strategy. Focusing on revenue, aiming for gradual growth, and achieving profitability could be a more prudent way to build a successful company in the long term, effectively abandoning the chase for venture capital and multi-million-dollar funding from funds.