Unicorn pretenders: falling behind the herd

It was not very long ago (Nov 2, 2013 to be precise) when Aileen Lee (aileenlee now at Kleiner Perkins, then at Cowboy Ventures) famously standardized the term “Unicorn” to tag startups that were valued over $1B by public or private market investors. Over the 30 months since then, we have gone from 39 members in the exclusive Unicorn club to over 161 (as of this writing, according to the real-time updated list at CB Insights). Companies like Uber have attained valuations in excess of $50B.

Then the summer of 2015 happened

First, private investors began grumbling about valuations getting unhinged from any real metrics for value. Unicorn valuations were being driven primarily by “FOMO” at ever-larger venture funds and the entry of non-traditional but large pools of institutional capital. Both of these sources of cheap capital were artefacts of the “near-zero / negative” interest rate regime ushered in by the monetary easing that followed the financial crisis of 2008. Next, some of the larger and more public visible pools of capital started applying some hygiene to their valuation methods. My detailed post in November — “Unicorn Markdowns Widely Misunderstood” — posited that the fundamentals underlying the more visible Unicorns were still fairly solid but fund-accounting methods and audit processes were resulting in mark downs.

However, the leaders in the pack of Unicorns have been showing solid growth right through this period of hand wringing. Uber (as per my estimates from leaked data) closed 2015 at $5.7B in gross bookings and $1.4B in Net Revenue and quarter-on-quarter growth exceeded 40% there. Airbnb reportedly grew from $500M to $1B in revenue in 2015. The secretive Palantir reportedly pulled in $1B in revenue in 2014. Each is still valued over 25x revenues so they have a long way to go towards growing into their valuations (as last priced by the market) but nobody is questioning their membership in the club.

The misfits

Two interesting (and perhaps schadenfreude inducing) stories have emerged of late. These recount the near-simultaneous unraveling of (arguably) couple of the most visible members of the Unicorn club.

Theranos and Powa Technologies, each grew to dizzying heights and fell from grace spectacularly; the former is fighting to survive while the latter is under administration (a form of insolvency in the UK). It is worth examining the similarities between the two. Detailed coverage on Theranos and Powa Technologies are worthy long reads.

The differences between the companies are worth noting as they make the similarities more stark:

1. Theranos attained valuations over $9B and was a leading Unicorn based in Silicon Valley; Powa at $2.7B was middling at best, but a flag bearer for UK entrepreneurship
2. Theranos is unique in its sector ( diagnostics) as one of 8 unicorns in healthcare; Powa operates in a more crowded fintech space with as many as 36 in the list (as of 2015) with 11 operating directly in the same sector (payments)
3. Theranos was founded in heart of Silicon Valley by a 19 year old first-time founder who “checked all the boxes” for the microculture of success that pervades it: a charismatic Stanford dropout, black turtlenecks for a uniform and a singular grand vision; Powa on the other hand was founded by a 63 year old serial entrepreneur in the UK who was a consummate salesman who had successfully sold all manner of products and services ranging from hi-fi equipment, to advertising and online web presence and pivoted his business more than once
4. Theranos was backed by some of the best investors in Silicon Valley (including DFJ and Oracle founder Larry Ellison) to the tune of $680M, ostensibly all equity; Powa raised ~$180M, all from Wellington Capital Management (a non-traditional investor in startups, a company better known as an asset manager for public investors) with up to a third of it ostensibly as debt

Pretension patterns

The similarities between the stories at Theranos and Powa make for good lessons in investment scrutiny (in order of what I think should have been obvious flags):

1. Neither company has a technology proven to work: Theranos for all their claims of using a pin-prick to run a battery of over 300 blood tests had only been certified for one: a test for herpes. Powa’s point-of-sale (PowaPOS) product was never successfully released and the consumer payment app (PowaTag) saw minimal uptake as QR codes have never caught on. [tweet this]
2. Both companies avoided external validation of their technology: Theranos actively blocked peer-review processes using the pretext of trade secrets and IP protection, although these are de-rigeur in healthcare. Powa reportedly never discussed their technology or performed interoperability tests or showed up at conferences related to payments to discuss ecosystem and standardization efforts. [tweet this]
3. Sales stepped up, when the product did not show up: Both companies have been referred to as using “smoke and mirrors” and sold promises rather than products. The CEOs of both companies became media darlings and major luminaries and politicians fell for the story being told rather than the proven value of the product they were building. Customers, partners, investors and the media lapped up a narrative that the charismatic CEOs repeated over and over again until eventually some among them started asking the right questions.
4. One key strategic partner was the only demonstrable measure of progress: In Theranos, Walgreens bet big in terms of cash ($50M ?) and a commitment to 300 stores, but never bothered to check the efficacy of the product. Powa painted a picture of China delivering $2B in revenue based on a relationship with China Union Pay — a product integration that was never delivered. [tweet this]
5. When the going got tough, both CEOs threw technologists under the bus: Elizabeth Holmes, the founder/CEO at Theranos says “I thought we were doing things right all along” in this video, which I interpret as a claim that she had been misled by her lab technicians. The only remedy she offered when questions were first raised was the firing of her lab director. Powa’s Dan Wagner routinely fired developers when unrealistic deliverable deadlines were not met. Both CEOs continue to say “it was not my fault” and “we will re-emerge stronger”. [tweet this]
6. Investors and partners bought into the dazzle without diligence: In the case of Theranos, it appears to be a classic case of “social loafing” where everybody thought someone else had done the diligence [tweet this]. Nobody bothered to personally validate the claims of a young charismatic founder with a magical cure for the fear of needles. Dan Wagner at Powa ended up with a completely inappropriate investor and capital structure for a business that had minimal revenue to support a $60M+ debt line and expenses of over $50M+ per year [tweet this]. His path may have been different had he raised less money from proven early-stage and diligent investors.

Are there other pretenders out there?

There undoubtedly are several in this pack of 139 and it will likely take more journalistic endeavors to expose them (as in the case of Theranos) unless their flawed models kill them from within first (as in the case of Powa). The secrecy and mystique surrounding Palantir is worth a second look perhaps in this context but I believe there are enough proof points to validate their technology.

However, in this list of Unicorns there undoubtedly are other dubious claims lurking in the the guise of promising bio-science or in the promise of disrupting regulated industries or in bringing new technology to emerging markets.