Unicorns, cockroaches and the walking dead

Repeat after me. Unicorns are NOT real.

Unicorns are mythical creatures. But especially in the Silicon Valley, unicorns have taken on a life of their own. Aileen Lee’s article about the Unicorn Club with its list of billion-dollar valuation companies was a great disservice to startups. The article went viral, and suddenly, it became a badge of honor to become a unicorn. You’d officially “made it” if your company was on the list. In November 2013 there were 39 companies in the Unicorn Club, and by January 2016 there were 229 unicorn startups.

It’s the valuations that are mythical

Here is the hard truth. Based on the lifecycles of 3,000 software companies between 1980 and 2012 around the world, McKinsey found that only 96 companies reached $1 billion in annual sales, and only 17 companies (0.6 percent) grew beyond $4 billion. On average, there are only 50-100 exits for more than $100 million in any given year.

If you measure your success by whether you’re a unicorn, you’re more likely to fail. We’re seeing it everyday as fund managers write down their investments in startups including Evernote, Cloudera, Dropbox and MongoDB.

There’s a long list of high profile misfires where employees and investors are left with nothing. A few examples include:

• Good Technology recently sold at less than half its prior valuation – and employees received nothing. Not surprisingly, there’s a lawsuit pending from employees who were left empty-handed after its venture-backed company went south.
• SunEdison started as a silicon chip innovator and became the world’s biggest developer of renewable energy projects. Worth almost $10 billion a year ago, the company grew too fast, overpromised and under delivered on projects, and burned through its money. Last month, SunEdison filed for bankruptcy.
• Rewind a few years ago, and Zynga was synonymous with mass market gaming. But in the years following its IPO, the company lost $600 million, replaced its CEO, and laid off hundreds of employees. The company still exists, but is still hoping for a turnaround.

Build a profitable business model

The moral of the story is to stop chasing valuations and instead focus on building a profitable business model. Don’t fixate your strategy and initiatives around valuation, but look out for all stakeholders – including the founders, investors, employees, customers, and option holders. If you ignore this, you are creating a forced imbalance that will only make things worse when there is an eventual market correction.

The fact is, very few startups are suited to be billion-dollar businesses. When you look at the Fortune 500 list, one of the key characteristics is that they prioritize strong ideas over financial capital. What keeps the world’s biggest brands on this list each year is their ability to create superior ideas year after year, and adapt to the needs of the market.

Become a cockroach, not a unicorn

As unicorns continue to lose their horns, the companies that will survive are cockroaches. They don’t sound as glamorous, but they are growing and profitable. They are experiencing slower and steadier growth. They are capital efficient and don’t need to take on additional capital. Because they are so resilient, their valuations are difficult to define by investors, as there is no “next round” of funding.

Stock markets value steady growth over big promises that don’t pan out. Volatility is a scary thing to an investor. Stocks that experience steady growth typically avoid the drama of instability and erratic earnings growth. Any sound investor will advise that successful investing is a marathon activity, not a sprint.

In the business world, cockroaches will outlast funding shortages, stock market crashes and can survive in a future with little money in it. They’re highly agile and can pivot into other revenue-generating business models. And they really do survive any nuclear explosion – although up to a point.

Ninety-five percent of startups are better suited to be a cockroach. As I mentioned in an earlier post, it’s easy to be caught in the hype around raising capital, billion-dollar valuations and massive exits. But I’ve found that after bootstrapping Replicon for many years, it helped us to be steady and persistent in achieving long-term growth and profitability.

And finally, the Walking Dead

When a cockroach thinks that it is a unicorn and convinces investors that it is one, they become a Walking Dead. By all accounts these companies seem to be successful unicorns, but this is only the case on paper. In reality, these companies hang around for too long, and lack strategy and vision. Eventually, they are killed off.

It can be very difficult to initially identify a Walking Dead, as you don’t immediately know who has been affected (or rather, “infected”). But they start to show symptoms after a little while that they are not what they seem. It may start out small – like a freeze on hiring. But then the issues snowball – and whether it’s layoffs, low employee morale, missing revenue targets or re-pricing, it becomes an incurable condition for these companies.

The market will always go through ebbs and flows. If you’re a unicorn or a Walking Dead, you have a lot to worry about with plummeting valuations, layoffs and the constant threat of more innovative competitors. Many startups are ill-prepared to anticipate and move with the pace of change. For entrepreneurs, now’s the time to understand what type of company they are, and set up the building blocks for their long-term growth and success.