Focus on “Unit Econ” not Unicorn
If there is one word that has single-handedly created buzz and hype in the start-up world, it is “unicorn”, a word coined in 2013 signifying companies that are over $1B in private market valuation. This title word has become a trophy-word; a yardstick of achievement for the entrepreneurs, investors and the media. Public statements are often made on the number of unicorns India has today, with predictions on more start-ups that will enter the unicorn club in the near future.
The psychological gratification received upon becoming a unicorn has caused both entrepreneurs and investors to make this a stated goal. This motivates start-ups to rapidly launch without thinking through a business case and use incentives to spur adoption with the goal of gaining the coveted unicorn status in the shortest possible time. Little attention is paid to unit economics or even a business model. Investors are equally to blame since some of them often value companies in financings based on vanity metrics such as user traction and not business economics. As a result of this unicorn chase, what could have been achieved with $1 of investment is achieved with $5. Series A or B companies with negligible revenues are being valued at hundreds of millions. A growth investor I spoke with said that he was excited to invest in a pre-revenue company with no business model in sight at a valuation of several hundred million because of the company’s excellent user traction.
As recently seen with Uber and WeWork, financing valuations have little correlation to the valuation at an IPO. Public investors like to see that the company has a clear path to profitability or is close to it. Billion dollar acquisitions for companies that are not generating profits are not commonplace. Very few companies get lucky or deserve such an exit. For the companies without a sustainable business model, down round financings, distressed sales or shut downs become a reality when they run out of money. We have begun to see such events in India recently and we will see a lot more in the coming years. An early focus on unit economics tests the value proposition of a company before a lot of money is wasted in vanity metrics based growth. Will customers pay a fair price once costs are at steady state for the company to be able to make money? You don’t need to be profitable but you need to know how to get there. Brilliant founders of so-called “unicorns” who spend years of their lives building their start-ups based on vanity growth metrics end up as the ultimate losers due to their low equity ownership and ballooning liquidation preference stacks in a company that may have a shaky business model.
Creating billion dollars of value on the back of unit economic led growth deserves the “unicorn” badge along with the glory associated with it because of its rarity, just like the mythical animal it is named after. Private financing led billion dollar valuations in cash fuelled, incentive-driven businesses with no unit economics in sight, don’t deserve the same recognition. The entire start-up ecosystem — entrepreneurs, investors, media — need to play their part to help steer start-ups towards the right goal. The goal should be “unit econ” and not “unicorn”.
Suvir Sujan, Nexus Venture Partners
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