The hidden fragility in today’s startup unicorn boom

For more than a decade, the image of the "unicorn" has dominated the venture capital imagination: the mythical billion-dollar startup destined to change industries, mint fortunes, and capture headlines.

As the global funding boom subsides and scrutiny of private valuations intensifies, it is becoming clear that many of these unicorns are just simple mules in disguise (no offence intended), ordinary businesses dressed in fantastical valuations that crumble under closer inspection. 

At the core of the unicorn problem lies the way valuations are constructed. Unlike public markets, where share prices reflect daily trading by thousands of investors, private valuations are often the product of bespoke negotiations between founders and a handful of venture capitalists.

The result is headline valuations that tell only part of the story. Preferred shares come with liquidation preferences, ratchets, and other protective structures that inflate a company’s paper worth, yet say little about the value that common shareholders or public market investors would ultimately realise.

A study by researchers at Stanford and the University of British Columbia found that nearly half of unicorns were overvalued by at least 48% when these terms were accounted for. 

Another issue is the persistent absence of profitability. Many unicorns have achieved their status not by building sustainable, profitable enterprises, but by pursuing growth at any cost. They subsidise consumers, underprice services, and rely on ever-larger funding rounds to plug gaping cash-flow deficits. 

According to CB Insights, fewer than 10% of unicorns are consistently profitable. In public markets, companies without a clear path to earnings are punished; in venture circles, they are too often celebrated as visionaries. 

The explosion of unicorns coincided with an era of cheap capital. Ultra-low interest rates after the 2008 financial crisis pushed institutional investors to hunt for yield in alternative assets, flooding venture capital with unprecedented dry powder, over $580 billion globally by 2022.

Startups that once would have struggled to raise $50 million suddenly found themselves awash in nine-figure rounds. Cheap money encouraged bloat, producing business models predicated on unsustainable subsidies, and unit economics that only worked when capital was virtually free. With interest rates now higher, many unicorns are facing harsh new realities. 

Unicorns rely on the promise of a lucrative exit, either via IPO or acquisition. IPO markets, however, have chilled. In 2023, venture-backed IPOs plummeted to their lowest levels in over a decade. Large tech acquirers are constrained by regulatory scrutiny and their own shifting priorities.

That leaves many unicorns stuck in limbo: too big to be acquired easily, too fragile to withstand public market scrutiny, and increasingly reliant on down rounds or emergency financings to survive. The glow of unicorn status fades quickly when the exit door is shut. 

Many unicorns are also competing in markets with winner-take-most dynamics. Ride-hailing, food delivery, ecommerce, logistics, and AI tooling all exhibit strong network effects that disproportionately reward the leader.

For every Uber, there are a dozen regional players burning cash in pursuit of dominance they are unlikely to achieve. Many unicorns are effectively number three or four in markets that will only sustain one or two winners. Their valuations assume future market leadership that is statistically improbable. 

Unicorn mania has also distorted our sense of success. For every celebrated unicorn, there are dozens of fallen stars, companies that once reached billion-dollar status but later faced down rounds, acquisitions below last valuation, or outright collapse.

PitchBook data suggests that up to half of unicorns eventually lose their status. The narrative persists that unicorn status is itself a marker of success, rather than a fragile and often fleeting milestone. 

The problem is not ambition. Innovation thrives on bold bets, and transformative companies will always emerge from the venture ecosystem. The real issue is the conflation of valuation with value.

Investors, founders, and the media have too often mistaken paper unicorns for durable businesses. As capital markets recalibrate, it may be time to retire the unicorn metaphor altogether. What startups need are sturdier identities: businesses that earn the trust of customers, generate cash sustainably, and grow at a pace their economics can support. 

The venture ecosystem—hit by a rising interest rate environment and a string of high-profile flameouts—has an opportunity to move beyond mythical creatures. True innovation does not require disguises. It requires building businesses that are as extraordinary in substance as they are in story.

Eshan Kaul is an Investment Partner at Sinarmas Technology.