COMMENTARY: Unicorns in Zoos: The Rise of Billion Dollar Companies

Aidan Cullen, Stanford University

What makes a unicorn magical? While one could argue it’s the horn protruding from their head that grants unicorns their magic, perhaps it is their rarity that makes them so special. They are so rare that, in fact, they are nonexistent. Pasted on posters and made into countless toys, unicorns have become a symbol of mysticism in society. So, it makes sense that founder of Cowboy Ventures, Aileen Lee, coined the term “unicorn” for the rarest club for private companies in her 2013 TechCrunch article. She defines the term as a privately-held startup valued at over $1 billion. At the time, “unicorn” was the perfect term, since there were only 39 companies in the billion dollar club. However, how would this term fare if the amount of billion dollar startups increased? Would the increase in highly valued startups crowd markets? Is the term “unicorn” still worth anything if there are so many of them? If a unicorn could be found in a zoo, would they continue to instill such wonder? 

Although there has been a rapid increase in the number of unicorns during the past few years, growth stalled in 2022 and they remain extremely rare. Additionally, tech markets have grown in size and number to coincide with the growth of unicorns, so unicorns’ share in the market is not any larger than it was before.

Nevertheless, the recent ‘unicorn boom’ has been a sight to behold. The CB Insights infographic below shows that in comparison to 2020, 2021 saw a massive 70% increase in the number of unicorn companies. At the end of 2020, there were 563 unicorn companies, but at the end of 2021, that number became 959. Then, fittingly, the 1,000th unicorn was achieved on February 2nd, 2022.

According to recent CB Insights data, there are now 1,205 unicorns worldwide. But what has caused this surge?

In his blog, “Above the Crowd,” venture capitalist Bill Gurley offers a potential explanation: “Late-stage investors, desperately afraid of missing out on acquiring shareholding positions in possible ‘unicorn’ companies, have essentially abandoned their traditional risk analysis. Traditional early-stage investors, institutional public investors, and anyone with extra millions are rushing into the high-stakes, late-stage game.” The trend that Gurley identified in this 2015 article is highly pertinent to last year’s unicorn growth, and it is central to the core principle of venture capital. 

You can think of venture capital like baseball. The most common metric in baseball is batting average, which is a ratio of your hits to your total number of at-bats. The average baseball player has a batting average of around 0.250. However, venture capitalists value a different metric: home runs per at-bat. Hitting singles, doubles, or triples is great and contributes to your batting average, but it doesn’t benefit your returns quite like hitting a home run. In fact, Len Batterson, the Founder and CEO of VCapital, notes that “a top quartile venture capitalist must hit at least a couple of home runs out of every ten to twelve investments—the VC who hits two out of ten investments as home runs is a superstar.” 

Unicorns are exactly the home run that investors are looking for, so it makes intuitive sense that investors are flocking to invest in companies that show unicorn potential. According to Pitchbook’s Q3 2021 NVCA report, “The rise of nontraditional investors remains an ongoing storyline; through September 30, this group took part in rounds accounting for 33.5% of the year’s deal count but 77% of its value.” Nontraditional investors, typically classified as hedge funds, private equity firms, mutual funds, etc., are pouring money into the startup ecosystem and driving up valuations as a result. More and more investors are worried they’ll miss out on the next big unicorn, so they’re taking on more risk in the hope that they will hit a home run. 

There is also a strong correlation between interest rates and the amount of unicorn companies. This is another factor that makes intuitive sense: If money is cheaper, investors are more likely to invest in startups. Taking a look at the charts below, the first of which depicts the amount of unicorn valuations granted in each quarter, and the second of which shows the American federal funds rate over time, there is a clear inverse relationship between the federal funds rate and the number of new unicorns in a particular quarter. 

As the first graph indicates, the number of unicorns fell substantially during the first three quarters of 2022. The rising interest rates, depicted by the second chart, are a major reason for the drop. Because of rampant inflation, the Federal Reserve chose to increase interest rates, which made capital more expensive. Kyle Stanford, a senior analyst with PitchBook Data, explains that due to the central bank’s actions, “big investors such as pension funds and sovereign wealth funds abruptly left the venture capital market to focus on less risky and long-term investments.” 

Although the amount of unicorn valuations has fluctuated over the past two years, there remains one common fact: Unicorns are extremely rare. In fact, only 0.00006% of startups become unicorns. So while external factors may bolster or repress the number of unicorn valuations, it is still incredibly uncommon for a company to achieve the hallowed status.

Does an increase in unicorn valuations have a negative impact on the economy? And aside from a fancy label and talking point to hire top talent, why should people care? While the label may not matter much on its own, the market power these companies obtain with the capital does. With the growth of unicorns brings the growth of their markets. 

A CB Insights report found that Fintech is the largest market for unicorns, encapsulating 21% of all unicorns. According to Statista, in 2021, investments into the Fintech market increased to $225.5 billion, up from $127.7 billion the year prior. So, even though the amount of unicorns grew rapidly during this time, the overall market did as well.

Maybe another metaphor will clear things up. A young pet tortoise—bear with me—can be put into just about any enclosure. However, it only grows as big as its environment will allow. So when put into a bigger terrarium, it will grow bigger than it ever would have otherwise. Similarly, if the market doesn’t grow, neither can the amount of unicorns. So, the issue of a crowded market is not as pressing as it might seem. 

Specific niches can grow within a market as well. Not every fintech startup is tackling the same problem and targeting the same demographic. For example, Venmo and Klarna are both fintech companies, but their products are completely different and their target markets do not overlap in harmful ways. Hubert Palan, the Founder and CEO of Productboard (the 1000th unicorn), put it well in his interview with the Financial Review: “It’s not like there’s 1000 unicorns in the product management space. That would suck.”

So, with tech businesses growing at a rapid pace, the concurrent rise in unicorns isn’t crowding the market. The lesson here? If you’re planning on keeping a unicorn in a zoo, make sure the enclosure is big enough. Otherwise, the mystical unicorn might just end up looking like a horse with a funny horn.

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