Fabled animals and fantastical creatures…

Unicorns used to be seen only on coats of arms, or in the pages of mediaeval romances, as mythical beasts with the power to grant those who were pure of heart and of a virtuous nature wisdom and miraculous powers, while the Cheshire Cat was made popular in Lewis Carroll’s Alice’s Adventures in Wonderland, often disappearing and leaving behind only its grin.

Now, of course, unicorns are proliferating at an unprecedented rate across the world, characterized by those start-up, or relatively new, non-public market businesses which have raised funding at levels that give the overall enterprise a valuation of over USD 1BN, or equivalent.

So, one has to assume that the title of a recent paper by 2 professors, Martin Kenney of UC Davis and John Zysman of UC Berkeley, entitled “Unicorns, Cheshire Cats and the New Dilemmas of Entrepreneurial Finance?” (which we commend as worth reading in its entirety) was designed in part at least to poke fun and provoke.

In it, the authors postulate that, post the “dot.com” crash of 2000, the combination of decreased costs, and increased speed of entry to a market provided by the growth in open source software, digital platforms and cloud computing led to what one might term a “phase change” in not only the number of start-ups, but also the diversity and scale of private funding sources, as well as the infrastructure (incubators and accelerators) available to encourage the developing ecosystem.

It is certainly a strange world in which Masayoshi Son’s Softbank, with supposedly USD 100BN to deploy, has refined what we like to think of as the “Reverse Highwayman”- “Take the money, or else the business gets it…!” (so to speak). This has led to an economic arm’s race, in which Venture Capital (VC) investors seem compelled to advertise that they are raising ever larger funds to make sure they are not left out as the price of entry keeps rising.

Apart from the serious dislocations being seen in the San Francisco Bay Area’s housing market and social patterns, these developments bring to mind the usual thought: “How will it all end?” Whole industries are being up-ended by the entry of competitors who are able to bear large losses and burn ridiculous amounts of cash for longer than before, in the hope that eventually they will not only supplant the hitherto dominant incumbents, but also out-compete (as the paper’s authors state) “other lavishly-funded start-ups”, who have also had the temerity to attempt to enter the same space. VC was always intended to provide entrepreneurs with (another quotation) “sufficient funding to cross the infamous “financial valley of death””- which is not quite as life-threatening and foolhardily brave as charging the Russian cannon at Balaclava, but hitherto probably had even higher casualty rates.

The irony here is that the collateral damage (the existing incumbents), which is usually conventionally and conservatively funded, has to be profitable in order to be able to compete and sustain the financial barrage from those aiming to put them out of business, because the insurgents are being allowed to play by different rules, in which rising attritional losses are a badge of honour- at least as long as the original “business case” is still seen as valid by its supporters. And this approach is exacerbated by the fact that, in many areas, there is a potential Winner Takes All (WTA) outcome in which the successful “platform” simply overwhelms all other competitors. Google’s search business is probably the most famous exemplar of that reality.

The problem with the WTA approach is that it has a corollary- LLA- the Losers Lose All, crashing to oblivion, having burned through their resources. As the paper’s authors state: “It may ultimately be the case that these Unicorns may turn out to be a very short-lived breed such as the Cheshire Cat… all that would remain was the iconic grin.” However, rather than dispensing wisdom and miracles, they may by then have laid waste to large sections of the economy and potentially changed the development of whole societies- but that is a topic for another post.

The Awbury Team


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