The End of Free Money: Unicorn Hunting

Eye-watering sums of money were poured into early-stage technology companies. As of 31 December 2022, SoftBank [9984.T] had invested $144bn since it established its two Vision Funds, SVF1 and SVF2, in 2017. Investment management firm Tiger Global Management, which according to Bloomberg, had $58bn in assets under management in late 2022, committed approximately $38.9bn in capital via 15 funds between 2003 and 2021, with almost $35bn of this total invested from 2012 onwards.

By July 2021, Tiger held stakes in more unicorns than any other firm, including AI developer OpenAI, TikTok-owner ByteDance and edtech platform BYJU’S. During that time, the investment manager developed a reputation for fast-paced investing, often paying over the odds for shares in the most promising start-ups in the marketplace. For example, in 2014, it helped lead an investment in Indian ecommerce platform Flipkart at a valuation up to four times the company’s sales. In early 2021, rumours circulated that Tiger considered purchasing shares in ByteDance at prices implying a $450bn valuation, just months after investors had valued the company at $180bn.

Rivals accused Tiger and SoftBank of letting due diligence fall by the wayside in their rush to acquire these stakes. Until recently, few within the firms cared. Tiger argued in a note to investors in June 2021 that its research showed it had “consistently underestimated” the technology start-up market, with its estimated size having jumped from $3trn to $5trn within the past six months. With growth rates that fast, there seemed little reason to worry about getting the best price for any given asset. What mattered was grabbing a slice before someone else did.

With VC investors so willing to pay outsized amounts for shares in technology companies, their values naturally soared. More and more crossed the $1bn threshold for unicorn status, with the number of unicorns created globally per year growing from five in 2010 to 161 in 2019, according to data from Tracxn. Tech Nation data shows a similar trend in the UK, with the country’s cumulative number of unicorns growing from 10 in 2010 to 77 in 2019.

Amounts raised in financing rounds ballooned throughout the period. JD.com’s [9618.HK] $1.5bn Series C in 2011 was the decade’s first $1bn+ funding round, with no more following until 2014. By 2016, however, multibillion-dollar fundraises had become commonplace, with both DiDi Global [DIDIY] and Ant Financial Services – now Ant Group [6688.HK] – raising $4.5bn in a single round. Ant Group went on to raise the largest funding round of all time, netting $14bn in its Series C in 2018.

Valuations went, and in some cases remain, off the charts. At the time of its record fundraise, Ant Group was reportedly valued at $150bn. Uber’s [UBER] 2019 IPO saw it valued at $82.4bn, up $20bn since it commenced a secondary financing round the previous year.

The onset of Covid accelerated this trend even further. According to data from Crunchbase, the number of $1bn+ valuations surged in 2021 to circa 600 from approximately 150 the previous year.

Big tech’s bull run

Although Silicon Valley start-ups attracted large investments, it was public technology companies that drove the stock market’s post-financial crash recovery. The tech-heavy Nasdaq nearly quadrupled in value in the 10 years to the start of 2020, outperforming the S&P 500’s growth by more than 100%.

“The thing about the whole tech sector is that [the companies are] high-growth, so they move the quickest,” says Reid. “That in itself creates FOMO [fear of missing out]. They move above and beyond the benchmark [in a low-interest rate market].”

However, the hype generated by VC investors didn’t always translate when companies were tested on the public markets.

Uber’s IPO was one such example. Despite the fact the company had burned through $10bn in operating costs with tight margins at both ends of its business, in the run-up to its IPO, valuations reached as high as $120bn.

“Uber is losing money,” said Ygal Arounian, an equity analyst at Wedbush Securities, ahead of the IPO, “and you have to have a little bit of a vision to see them taking that revenue and start turning it into profit.”

The IPO flopped: Uber’s $45 opening share price fell 8% on the day of its debut, the largest first-day dollar decline in US history. As of 1 May 2023, Uber has still never made a profit, and its shares trade over 27% below their opening price with a market cap of just over $65.9bn.

Uber’s IPO stands favourably, however, compared to that of UK delivery app Deliveroo [ROO.L]. Deliveroo became “the worst IPO in London’s history”, in the words of one of the company’s bankers, when it debuted in March 2021 and fell 26% on its first day.

Reid believes the hype around Deliveroo led, in the first instance, to its gross overvaluation. “You’ve got a delivery service, and you’re valued at $7.6bn. Okay, you’re [finding] a solution, but actually, you’re not an Apple [AAPL]. You’re not changing the world.” Since the stock began trading, Deliveroo’s shares have lost over 61.9% of their initial value (through 28 April).

Risky business

Signs of risk were evident in the early days of these investments. Better Place, an Israeli EV battery start-up that secured 2010’s largest financing round outside the pharmaceuticals sector, filed for bankruptcy less than three years after raising $350m. It emerged in the aftermath that, despite having attracted $800m in VC, Better Place had no real business model to speak of.

“This [early stage, innovative] area of the adoption curve has always been viewed as high risk with the potential for high reward,” says Cluver.

Despite this, and outside of early-stage companies, advocates of technology investing downplayed the risks involved. In 2017, Mad Money host Jim Cramer pointed to the earnings multiples that tech heavyweights like Microsoft [MSFT] and Cisco [CSCO] were trading at as evidence that these were “ridiculously undervalued” and “actually cheaper than the average stock in the S&P”.