Are unicorns a myth or reality?

Going by history, unicorns are mythical creatures. But in today’s start-up world, where unicorns refer to companies that notch up valuations of a billion dollars, will they turn out to be mythical too? Will their paper gains remain on paper or will they turn out to be real? Back in the days when venture investor Aileen Lee coined the term there was probably a handful of privately-held start-ups that commanded that kind of valuation. Fast forward to today, there are about 132 unicorns cumulatively valued at $489 billion according to a study by research firm CB Insights. Eight of them are Indian including e-commerce giants such as Flipkart and Snapdeal, Ola, Quikr, Paytm, Mu Sigma, Zomato and inMobi.

If that were not enough, in a recent study for The New York Times, CB Insights drew up a list of 50 companies that are likely to be the next set of unicorns. Among them are two newly minted start-ups — budget hotel aggregator OYO Rooms and hyperlocal delivery company, Grofers that promises delivery of grocery, food and toiletries within 90 minutes.

Founded in 2013, Grofers, has seen its valuation triple in the two months when it raised $35 million from Tiger Global and Sequoia Capital taking its cumulative fund raise to $45 million and valuing the firm at more than $100 million. OYO Rooms, which changed its model from finding short-stay accommodation to budget hotels, just raised $100 million from SoftBank valuing the company at more than $400 million taking the cumulative fundraise to more than $125 million in a span of a little over a year.

The next 50 unicorns

A study by CB Insights names two Indian start-ups Freshdesk and Grofers in its list of next unicorns

While there is no doubt these firms have rockstar entrepreneurs at the helm, the problem with creating paper unicorns is that the focus is all on the valuation and the money you raise rather than business metrics thus, sending out a message to other entrepreneurs that money raised is what determines success.

While in most consumer businesses, having a cash pile gives you a head start and buys you market share, both — the investors pumping in the money and the entrepreneur — know they are on borrowed time. A lot of the VCs say that getting a lot of cash early on often could lead the entrepreneur to accelerate when he should probably take a step back and build a better product or offering. “Some of them are spending money like drunken sailors,” says Kanwal Rekhi, a Silicon Valley veteran. And in the David vs Goliath battle where start-ups challenge the incumbents, at what cost will disruption come is an important question to ask.

Yet, what perpetuates this cash burn is the mad frenzy on the part of the investors, who in the fear of missing out on the next unicorn are pumping in a lot more money at the early stage not only to get their foot in the door but also to keep their costs down as they fund future rounds.

The problem with paper unicorns is that valuations may not be realistic for a long time. Even the CB Insights list of the next 50 unicorns was based on money raised, employee turnover and social media mentions rather than business metrics. Creating paper unicorns also means creating tougher exits as many of them are not ready to go public because they don’t have the numbers to support them, and of course, there aren’t enough companies that can afford to buy them out either.

Freshdesk, the third Indian company in the next 50 unicorns list and the oldest and only enterprise play among the three is probably the closest to a listing. With over 40,000 companies who use its cloud-based software to service their customers, Freshdesk has raised about $94 million across various rounds from investors such as Google Capital, Tiger Global and Accel Partners in its five-year existence.

Building a business is tough enough and when we layer that with unrealistic growth expectations which often comes as a result of valuations assigned, it could very quickly turn downhill both for the entrepreneurs and the investors. In this race to find the next unicorn, there are bound to be a lot of casualties. Somebody will pay the price and in all probability those will be the ones with the biggest moneybags.