Silicon Valley's Unicorn Companies are in Trouble - Here's Why

Coined by Aileen Lee of Cowboy Ventures, a "Unicorn" company is a startup that is valued at $1 billion or more - and growing. The catch: Unicorn companies aren't actually producing billions of dollars worth of revenue, but due to the size of investment, the company valuation grows to the lauded 10-figure sum.

Nevertheless, according to Silicon Valley seers, there’s blood in the water as 90% of unicorn companies are set to either run out of steam or simply fail.

There's many reasons for this, from unit economics to a glut of investors. Below, we discuss these trends to provide a better understanding of the rise - and potential fall - of Unicorn companies.

How Unicorn Companies Get Their Wings

High valuations are primarily gained through hiring the best talent, gathering lots of users, and shooting for the moon with huge 15% week-by-week growth rates. From a practical standpoint, it’s a demonstration of what the company could achieve on a larger scale.

If it’s a success, venture capitalists seek to scale it up through plunging huge amounts of money into the company, and thus increasing the valuation.

Nevertheless, the last year has seen downturns in many Unicorn companies.

For a deep analysis, check out our 2015 Venture Capital Investing Report.

Silicon Valley's Downturn Protections

A downturn protection is a safety valve that protects investors should something go wrong and the company’s value slumps. When these protections are built in, the employees and the stock takes a hit - not the investor. This can cripple morale and lead to many Unicorns failing to recover.

Facebook, for example, had no downturn protections built in and it benefitted them in the long-term. However, that doesn’t mean downturn protections are entirely bad.

Unstable Companies

The Unicorn companies that get into trouble tend to be consumer-facing brands with low margins. They have to rely on acquiring customers for a low cost. Even a slight change in the amount it costs to acquire a customer will lead to a lack of profitability and make the company unstable.

The problem is that a company valued so highly can be unstable simply because they are unable to ride out bad periods in the same way as established brands.

Another issue is many companies simply burn through the money they receive in an attempt to please investors and keep the market price high. To them, a downturn in the price of their stock is a disaster. Companies can’t survive with this in mind for long. It’s an artificial inflation of a company’s fortunes.

Poor Initial Public Offerings (IPOs)

There have been a number of failed IPOs among tech companies. The venture capitalists bite but the average person in the stock market doesn’t. This is a problem with many tech companies, including established brands like Twitter.

The CEO of 24 Option commented on this, “There is a continuing problem with unicorn companies and becoming overvalued. When this happens, it doesn’t take long for the market to discover the truth, which is why so many IPOs don’t go as well as people hoped.”

However, it would be wrong to say that all poor IPOs spell the end of a company. A valuation is nothing tangible - it's simply a prediction. Companies with substance that build a successful product will be able to overcome initial disappointments and return to profitability. Facebook continues to impress investors even after a rocky IPO.

These are the 10% of Unicorn companies mentioned earlier. There is a boom in unicorns, but it’s slowing down as people take a second look at what they put their money into.

The Future of Unicorn Companies

It’s incorrect to say that all Unicorn companies are destined to fail. On the contrary, there will certainly be a number of success stories in the coming years. For investors and employers alike, it’s a case of spotting when a Unicorn company is struggling.

Some of the main warning signs include:

· Stagnant employee counts: It’s difficult to sustain regular growth without hiring more people.

· Declining social media mention: Unicorn companies rely on a social buzz to continue going from strength to strength.

· It has already raised over $100 million: At this point, if the company still hasn’t managed to get off the ground the chances are it never will, or it will have to downsize in order to do it.

Finally, IPOs are rarely surprises. Most people are aware of when a company is about to go public. If this anticipation never builds, or it builds and then doesn’t happen, it’s pretty clear that the company is experiencing problems.

And that’s a worrying theme among Unicorn companies. They aren’t following through on their initial hype.

If you intend on investing in a unicorn company anytime soon, think twice. Currently, the market is experiencing a downturn, so now may not be the best time to get involved with these organizations.