Private equity Unicorns: legendary returns, harsh realities

Unicorns are the Holy Grail for investors. What are the challenges and risks with identifying and investing in them?

23 Jul 2018

Though they are becoming more common, the challenges and risks associated with identifying and investing in them are considerable, making it a nigh-on impossible task for the individual investor. However, a systematic, diversified approach of investing with top-quartile venture capital managers can meet these challenges and reduce risks, and has a proven track record of delivering exposure to unicorn companies. 

Unicorns are ubiquitous

Unicorns are supposed to be rare, but they are becoming more common. Sixty-six new unicorns were minted in 2017, according to CB Insights, compared with 36 in 2016, and 30, on average, per year since 2013. E-commerce, fintech, internet services, and healthcare sectors stand out, accounting for 106 of the 224 unicorns minted since 2013, with most of the total unicorns being located in US (115) and China (70). 

Unicorns are changing the world

Many unicorns are involved with businesses or concepts that are rapidly driving social change. The internet (GitHub, Dropbox, Slack), e-commerce (Wish, Flipkart, Houzz, Delivery Hero, Fanli, Kuodai), on-demand (Didi, Grab, Uber, Ofo, Mobike) are sectors that stand out, as well as hardware (Xiaomi, Jawbone), fintech (u51.com, Klarna, Transferwise), and social networks (Pintrest, Pinduoduo, Snapchat). Most of these have emerged quickly and have had a massive global impact in how we interact with others and spend our time and money – in short, how we live our lives.

And as the transition to a tech-driven future continues, if not accelerates, we'll expect to see more unicorns emerge in the coming years. Notable sectors to watch include artificial intelligence, virtual reality, augmented reality, smart transportation, and robotics.

Unicorns are emerging because of the relatively abundant availability of capital which allows many startups to stay private for longer rather than pursue an IPO. Add to this the increasing connectivity of the world through the internet, and the huge domestic user-bases in India and China alone are bound to lead to more unicorns as both these economies continue to digitize and consumers become increasingly affluent. 

Unicorns can deliver excellent returns but they are (really) hard to find

But while there are more unicorns emerging, they're really hard to find at an early stage, even for seasoned VC investors.

Furthermore, the odds of becoming a unicorn are very long - research by CB Insights, a US-based data firm, shows that only 1% of 1,098 US start-ups kicked off between 2008 and 2010 went on to become unicorns with a USD 1bn+ valuation,. Among these were Airbnb, Slack, and Uber, i.e. not a bad cohort.

There are many reasons why it's hard to identify unicorns, but here's three in particular:

  1. it's hard to look seven-to-eight years ahead and predict whether a business will work;
  2. it's challenging to develop a great idea into a viable business, even if there's a mass market for it over time; and,
  3. businesses suffer not through a lack of capital but a lack of knowhow and execution.

How can investors select and invest in unicorns?

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