
Expect Some Unicorns to Lose Their Horns, and It Won’t Be Pretty - jaoued
http://www.nytimes.com/2016/01/20/business/dealbook/expect-some-unicorns-to-lose-their-horns-and-it-wont-be-pretty.html
======
hluska
I was pleasantly surprised by this article.

I expected the usual 'the end is nigh, the bubble has popped, unicorns are
screwed, we're all screwed' article. Instead, I was happy to find that it was
about some of the ways that unicorns could or may have to protect employees,
founders and early investors from down rounds. Purely as an educational
experience, this article is certainly worth a read.

~~~
rcarrigan87
Yeah, it really is interesting to see the situation from multiple
perspectives. I still wonder though, is this actually happening? Nothing in
the many articles I've read suggests solid evidence that a majority of these
companies are struggling. Just sound bytes from VCs pontificating.

~~~
smt88
"Struggling" is not the same as "no longer able to justify a highly optimistic
valuation". Many unicorns could actually be profitable and still never justify
a $1B+ valuation.

------
ewindisch
It's been argued that the deal structure of companies, particularly unicorns,
has begun to look like debt[1].

Low interest rates and easy money has created debt. Massive bubbling amount of
debt. Crashing debt bubbles is not fun, just ask anyone that lost their shirt
in 1929. There is a paper[2] from this past June that goes deep into this,
highlighting how and why debt bubbles are so dangerous. TL;DR? At least
checkout this Bloomsberg article[3].

I think there will be a number of unicorns that are successful. I don't even
think this will only be those that are profitable. Like always, there are
companies that are overvalued, and some that are undervalued. I don't think
it's a 10/90 split as has been suggested by some, but the next couple years
will certainly be interesting.

[1] [http://blog.samaltman.com/the-tech-bust-
of-2015](http://blog.samaltman.com/the-tech-bust-of-2015)

[2]
[http://conference.nber.org/confer/2015/EASE15/Jorda_Schulari...](http://conference.nber.org/confer/2015/EASE15/Jorda_Schularick_Taylor.pdf)

[3] [http://www.bloombergview.com/articles/2015-06-26/the-
reason-...](http://www.bloombergview.com/articles/2015-06-26/the-reason-debt-
bubbles-are-worse-than-stock-bubbles)

~~~
at5
Have to disagree. They're still preferred equity instruments with unique
trigger provisions. Higher up in the capital structure but not debt; you can't
credit bid using these instruments in a Chapter 11 scenario and they aren't
afforded the same protections in bankruptcy court. What attracts investors to
debt instruments are the interest payments. You'd prefer PIK (payment in kind)
interest on debt as opposed to cash payments in a low interest rate
environment but that doesn't translate to pref equity instruments.

The unique feature of debt vs equity is that debt has a concave investment
profile; you know exactly what you should be getting upon maturity (principal
+ interest payments). Equity has a convex investment profile; you get the
residual value after subtracting face value of debt from the enterprise value.

~~~
roymurdock
Great points.

I think the confusion is due to the fact that debt can (and will) be
restructured in a downturn, just as equity will lose value. So they're both
risky when you make a poor investment.

But, as you note, debt and equity both have distinct risk and payoff profiles
that are determined by law.

------
daenz
Am I reading this right?:

    
    
      1. Early investors overvalue a company at $X+Y
      2. Investors give money and get Z preferred shares at valuation $X+Y
      3. New investment round, company valued at $X
      4. Wealth transferred from founders and employees -> original investors to cover the difference $Y

~~~
nickff
Yes, that is how 'liquidation preferences' work.[1] I strongly recommend
reading/watching Mark Suster, who (in my opinion) does a good job at
explaining investors and terms.[2][3]

[1]
[https://en.wikipedia.org/wiki/Liquidation_preference](https://en.wikipedia.org/wiki/Liquidation_preference)

[2]
[http://ecorner.stanford.edu/authorMaterialInfo.html?mid=2516](http://ecorner.stanford.edu/authorMaterialInfo.html?mid=2516)

[3] [http://www.bothsidesofthetable.com/](http://www.bothsidesofthetable.com/)

~~~
hobbyjogger
Just thought I'd point out that the example given doesn't tell us anything
about liquidation preferences (though of course you can assume they would be
involved, since we're talking VCs here, but they don't matter).

The relevant financing term here is anti-dilution. Here's Feld:
[http://www.feld.com/archives/2005/03/term-sheet-anti-
dilutio...](http://www.feld.com/archives/2005/03/term-sheet-anti-
dilution.html).

------
rcarrigan87
This is almost becoming a self-fulfilling prophecy. Enough articles are
written calling for down rounds, now investors are thinking down rounds,
employees are sprucing up their resumes, lawyers are preparing for battle...

Can anyone really say if there is any proof to this rhetoric. Are these
companies really in such bad shape?

*edit: spelling

~~~
chishaku
> Can anyone really say if there is any proof to this rhetoric. Are these
> companies really in such bad shape?

One thing is for sure, you can't look at companies/startups or VC in a vacuum.

You'd be wise to look at financial markets as a whole and all the
interdependent factors that __might__ be leading to a situation similar to
2008/9 or worse; another housing bubble, weakness in energy markets, banks
exposure to housing and energy, weakness in emerging markets (China, Brazil),
tightening monetary policy, sovereign debt crises, geopolitical risk, etc.

If investor and consumer confidence really start to slide, yes, valuations
will take a hit.

That's not to say that some unicorns and other companies can't still be wildly
successful.

~~~
sjg007
Technically we don't know until the SEC filing. This is why IPOs become down
rounds.

Sometimes a public ally traded institutional investor can shed light on a
private companies value based on required public disclosures.

------
kartickv
If I were a founder who wanted to make sure employees and founders get a
better deal, what are my options?

Can I accept money from investors only on the condition that they get paid
only after employees and founders get paid a minimum amount, like $1M each?

The stronger version of idea is to not grant stock / stock options to
employees (or grant only one share if needed for legal reasons). Instead offer
a guarantee that only after they earn some large amount, enough to retire, say
$10 million, will any investor receive anything. Employees would never make
more than $10 million, but they would maximise the chance of making $10
million. This would make the startup a less risky place for an employee to
work, assuming the goal is to maximise the probability of making enough to
retire. Then the investors can have whatever liquidation preferences,
seniority, ratchets and so on, as they want, and it wouldn't matter to either
the founders or the employees.

I'm willing to accept a lower valuation (the certainty of a $100 million
company is more important to me than a 20% chance of a billion dollar
company).

Does this make sense? Would you suggest a different approach to reduce risk
for founders and employees?

~~~
greggman
I'm confused. Employees and founders get a salary. There is no risk to them.
If the company fails the investors lose millions of dollars, the founders and
employees leave with 1-2-3 years of salary in their pockets and then go get
another job.

That is why investors get paid first. Am I missing something? I guess I don't
understand where this idea that founders and employees should get paid first.
In guessing because the did the work but they seem to be forgetting they also
got paid for the work. As a startup it might have been less than some other
jobs, in compensation they took some tiny tiny risk that if the company is
successful they get a taste. But they risk is orders of magnitude less than
the investors.

Sorry if I'm not understanding

~~~
ken47
The ethics of this go deeper than what you describe. If Warren Buffett invests
1m in a company, is he in a riskier position than if a McDonald's clerk were
to invest 10k in the same company? The absolute dollar value is not the only
way to gauge risk exposure.

~~~
kartickv
Not only is the McD clerk less able to afford loss, she doesn't get the
opportunity to diversify risks, as Warren Buffett does by investing in many
companies.

------
davidw
I expect 'unicorn' references to horns and such to be thoroughly worn out by
the end of the year.

~~~
numbsafari
You mean by the end of January.

------
27182818284
When I read old case studies like WebVan it is hard for me to believe in a
bubble. I do think their valuations are too high, but they certainly aren't
zero--more than half of the people I know have taken and Uber or Lyft more
than once, for example.

~~~
adevine
WebVan isn't the right analogy - a real estate bubble is a better one.

In the .com bubble, no one was really sure how things would shake out, so
there were lots of companies who wouldn't have succeeded no matter how big
they got (the "losing money on every sale but making it up in volume" business
plan). When the .com bubble crashed, real estate was seen as a much stronger
investment because no matter how low it went, it was real "stuff" that had a
sort of intrinsic value - it may go down, but it wouldn't go to 0. A similar
thing happened in Tokyo real estate circa early 90s. A Tokyo apartment still
has a lot of value - you'd probably think it very expensive - but it's still
80% cheaper than it was at its peak.

The problem with lots of companies now isn't that they won't ever be
profitable, or that they don't have realistic business plans, it's just that
their valuation is way more than their earning stream will ever support. They
are valued at "we'll eventually take over the market" prices, even though
they'll only ever reach niche market status.

~~~
0xCMP
This is a great explanation. Remember that the value in a stock is that you're
owning X% of a business just like if you owned 100% of a coffee shop.

If you buy a coffee shop for 10% @ $100,000 that makes $10k/year you just
bought a company for a P/E of 10. The value of a stock in that company is in
the growth of that 10k over time that is either paid as a dividend or retained
and valued in to the price of the stock. If you don't make money, or make much
less than what you could be expected to grow, their value will fall.

------
ffumarola
Any thoughts on which unicorns are more situated to "weather the storm" and
which aren't?

~~~
genericresponse
Flipping through the list, my top 3 are Palantir, Spotify, and Zenefits.

I think Uber or Airbnb will stay and become huge, but they might both be
overvalued.

~~~
exw
I don't think you are viewing this through the right lense. Valuations are a
point in time vs. thinking about a company as a long-term investment - you
should more think about which of these businesses has the best long-term
potential to become the winner in a massive market, with a strong "moat" that
makes it hard to compete, as well as extraordinary margins.

Based on that criteria, Uber & AirBnB should be on top of this list, followed
by Palantir and Stripe. Zenefits has not really shown the type of defensible
traction that Uber / AirBnB have (right now they are simply a rapidly growing
insurance agent with a difficult-to-scale direct sales model). I would not add
Spotify to this list - bad margins, and hard to defend against Google / Apple.

~~~
npizzolato
I'm not going to speak to their ability to become winners in massive markets,
but I don't see how Uber or AirBnB have a strong moat that makes it hard to
compete. Both seem extraordinarily easy to switch away from to a competitor.
Many drivers already drive for both Uber and Lyft at the same time, and it's
very easy for consumers to use both apps. I haven't used AirBnB, but it seems
like it would be easy to list your apartment/house on multiple marketplaces.

~~~
exw
Both of these businesses have what are called supply-side network effects
([https://en.wikipedia.org/wiki/Network_effect](https://en.wikipedia.org/wiki/Network_effect)),
which are not as strong as demand-side effects, but can still lead to dominant
market positions. In more concrete terms this means that for you as a
consumer, there is no DIRECT additional value of someone else joining the
service (you don't care if your friend joins Uber), but the value of the
service does go up with every additional supplier that joins the network (for
Uber, this would mean shorter wait times when you want a car, etc.) The
defensibility of these types of services is created through their supplier
network, and their ability to create more value for those suppliers (and
consequently consumers as well) that the competition. Uber / AirBnB can then
use the revenue from their leading market position to innovate faster than
their competition, create more services for consumers, pay for distribution /
new customer acquisition, spend money on marketing and awareness, etc. all of
which leads to them creating a massive moat around their market that makes it
nearly impossible for anyone to compete with them.

------
frik
What are the best books about the 2000 dot-com bubble?

~~~
mark242
This is all you need to read:

[https://web.archive.org/web/20050715000000*/http://www.fucke...](https://web.archive.org/web/20050715000000*/http://www.fuckedcompany.com/)

~~~
pud
Founder of Fuckedcompany here.

Thanks!

I wrote a book, too:

[http://www.amazon.com/Fd-Companies-Spectacular-Dot-com-
Flame...](http://www.amazon.com/Fd-Companies-Spectacular-Dot-com-
Flameouts/dp/1416577939)

~~~
frik
Do you have a backup of your old website? Archive.org "backup" is
incomplete...

------
draw_down
Boy oh boy, this is all we talk about anymore. Always specifically in the
language of unicorns too. People seem to have really latched on to that.

~~~
kzhahou
You're getting downvoted, but there's lots of value in your statement.
Language is important, and the choice of words will frame narratives and
reveal hidden truths and agendas.

The press and HN/etc DOES talk a ton about unicorns. It's the only grade that
has its own name. There's no word for a $10-25m startup, or a $100-500m
startup. No, only $1B-unicorns. They have their own name and we're obsessed
with them. This either highlights or promotes the notion that investors (and
entrepreneurs?) are only interested in billion-dollar companies.

~~~
auntienomen
$10-25M: Goblin $25-50M: Elf $100-500M: Centaur

Please let this catch on.

~~~
abakker
I'd really enjoy "wizard" to be the graduated rank, like when you're
officially huge and profitable. Then, iOS/Android dispute becomes a wizard
battle.

------
jpmattia
Having had a front row seat to the popping bubble in 2000: I can't think of a
single instance where wash-outs (which is really what is being described in
the article) led to a wonderful outcome for employees.

Any other old-timers around that can name any?

~~~
gedy
Well, I did get to keep a nice office chair from the office cleanout that I
still use ;-)

------
tmaly
All the more reason to go public and have some liquidity in your shares.

I remember being at Intel in 1999 when the share price was 72. six months
later it was down around 18. There was one smart senior engineer there that
had put options as insurance against all his shares. The rest in that group
had to rethink retirement.

~~~
exw
<< There was one smart senior engineer there that had put options as insurance
against all his shares.>>

Not sure what the rules were at that time, but most public companies restrict
you today from owning any derivatives in their stock.

~~~
greenyoda
How could a company find out that you bought put options on their stock?

------
paulpauper
Haven't we been 'expecting' this since 2012, yet the biggest, most successful
unicorns keep going up in value.

For all the hype and doom about Square stock, the price is back to where it
was when it began trading a month ago, although it has fallen 20% in recent
weeks.

But this is a good opportunity for employees to understand the risks of stock
options, but it's not like the world is coming to an end. Such risks have
always existed.

~~~
Buttons840
Here's a 5 year old poll from HN:
[https://news.ycombinator.com/item?id=2231352](https://news.ycombinator.com/item?id=2231352)

The majority had a pessimistic outlook at at least thought "something is going
on".

------
mikeryan
It would be interesting to see if more founders take money off the table in
high value rounds as a hedge against down rounds. It's not mentioned but while
the founders may lose value in their common shares a lot of them have been
able to cash out in the good rounds giving them a nicer cushion compared to
straight employees

~~~
anon8418
Founders can take more money off the table, but that doesn't solve for the
bigger problem of down rounds mentioned in the article: employees leaving.

------
peter303
Sometime fake valuations. "I give you a boatload of money for a small piece of
your company" Doesnt mean the market or the prowess of the company will scale
way up beyond that small piece. Reminds me how they pumped IPOs in the late
1990s.

------
dageshi
META: Am I mad or has the term "Unicorn" suddenly blown up and now every news
outlet has to somehow shoehorn it into all their articles when dicussing
anything startup related?

I really don't recall the phrase before maybe a few months ago?

------
charonn0
This article needs a glossary.

------
flormmm
Don't the late stage investors get hurt in these deals also? Why would they
get in at such a high valuation?

~~~
rdmcfee
I believe that some startup founders/execs have optimized for valuation at the
expense of costly liquidation preferences for late stage investors.

------
KirinDave
Sometimes businesses fail, even after early success. And the NEW YORK TIMES IS
ON IT!

