Wealth Management and Financing August 20, 2020

Searching for Startup Unicorns in a Bear Market

A common feature of both bull and bear markets is the presence of unicorns, namely, those enterprises that are able to absorb the economic circumstances that markets throw at them and that thrive by serving new demands created by those circumstances. Many Silicon Valley investors thought they had identified the startup unicorns in their back yard, but the coronavirus market shock has shown just how rare those unicorns are.

As evidence of the ephemeral nature of a unicorn, consider the San Francisco short-term rental startup, WanderJaunt. This once-high flying company laid off a fourth of its staff after experiencing a slate of cancellations in March 2020. Likewise, Wonderschool, a start-up that connects parents with daycare and preschool providers, recently cut most of its staff after the demand for its services all but evaporated in March. Other startups, including ClassPass, which offers fitness class membership programs, scrambled to create video streaming services to replace the in-person services that they had previously provided.

Real unicorns, if they ever existed, may have gone extinct through the process of natural selection. The natural selection that is killing of Silicon Valley’s corporate unicorns is marching through the region at a blistering pace. The New York Times reports that upwards of 6,000 employees were furloughed from more than 50 startup companies in March. Startups that had attracted significant investor attention at the end of 2019 are now putting. plans for initial public offerings on hold. Newer tech companies are scrambling for a depleting pool of angel investor capital.

The companies that looked like durable unicorns, including Airbnb and other peer-to-peer sharing services, are fighting a two-front war. On one front, they are struggling to maintain their existing business; on the other front, they are fending off ever-present challenges from smaller companies that have a more disruptive mindset. The immediate effect is that the few survivors are suspending hiring or laying off staff and reducing or eliminating marketing budgets.

Some industry sectors might look like fertile ground for unicorns, including telemedicine, food delivery, online learning, remote work, and gaming. Separating the unicorns from the imposters in these sectors, however, will be a challenge to even the most seasoned venture capitalists. Given a few of the much-hyped but underperforming IPOs of 2019 (e.g. Uber, Lyft, WeWork), and in view of the COVID-19 pandemic, Silicon Valley venture capital firms are issuing blanket warnings to start-ups, leaving many of the riskiest start-ups exposed to the sudden termination of capital investments and an almost-certain death of thinly-capitalized enterprises.

Silicon Valley has never been known to accept defeat. Almost as quickly as some startups were closing up shop, others jumped in to take their place and respond to the conditions that drove many erstwhile unicorns away. Furloughed valley employees have rushed to sign up for Upstream and Silver Lining, networking apps that connect tech workers affected by coronavirus layoffs with companies that are still hiring. Hiring manages and recruiters are sharing weekly newsletters like Layoff List, which is published by Drafted, a Silicon Valley recruiting company. Tech veterans in the Valley know that venture investors may have shut off the startup money tap now, but the larger established tech companies are still sitting on piles of cash.

The startup unicorns that will survive the current shakeout are shifting to survival mode, in which they cut spending, lower prices on products, renegotiate fixed costs for things like leases and take advantage of government programs that have been hastily put into place to help small- to midsize businesses and their employees. Successful executives will adopt a “wartime C.E.O.” mentality that will have them doing whatever it takes to win in the face of the existential coronavirus threat. WanderJaunt, for example, may have laid off a fourth of its staff, but it also quickly transitioned from serving the needs of from vacation travelers to helping employees and others displaced by the virus, like stranded college students, people seeking a separate workspace or medical workers isolating themselves from family. In this environment, companies no longer have the luxury of taking days to make major decisions. Those decisions are now made in a matter of hours.

The venture capital that fuels the valley will likely sit back in the short run to let natural selection run its course and to allow struggling startups to fade away. A number of startup unicorns will die, but the relationships that fostered those startups will continue to breed new ideas and opportunities. One small San Francisco-based venture firm, Alpha Bridge Ventures, has committed to contribute $25,000 to founders that it backed for new startups if the founder’s existing company fails due to coronavirus issues. If a once-novel solution is no longer viable, a creative mind will always find something else that is.

Investors that seek to increase the values of their portfolios will need to work harder to find the viable startup unicorns in this market. They will always have the option of waiting for established venture capital firms to reopen their pocketbooks and then to follow that wave of investment, but that strategy may lead to forfeiture of early substantial gains. In every case, investors need to be prepared to leverage their capital resources and to act quickly when they do find an elusive but valuable opportunity.