In 2014, unicorns in the Initial Public Offerings (IPO) were known to be a mythical and rare breed, with only 39 of them in existence. However, they have multiplied extensively since then, with more than 360 of them in the world.
On the surface, their growth could be a reflection of a healthy financial market, but it is important for businesses to recognise the underlying economic issues that gave rise to the unicorn boom.
Repercussions from the recession
Repercussions from the last recession in 2009 has inevitably provided a conducive environment for the growth of unicorns. Interest rates have languished since 2009, which reduces the cost of borrowing and makes it difficult for investors and speculators to find decent returns in the stock market. The poor economic conditions and the weak financial market fuels desperation amongst them to invest during a company’s IPO valuation as returns elsewhere are insignificant.
Moreover, huge amounts of money are still in the financial system due to quantitative easing - the direct injection of money into the economy - employed by central banks in an attempt to bring their countries out of recession. The large sums of money flowing in the financial system has to go somewhere, and given that the main aim of the venture capitalists and speculators is to reap substantial dividends from their investments, pumping money during IPO valuations is perceived to be a lucrative option.
A parallel from the past
The over-valuation of IPOs in recent years suggests a parallel of the Dotcom bubble in the late 1990s and the real-estate bubble in the 2000s, all of which stemmed from speculative investments. Currently, the stampede of unicorn IPOs reflect mass speculative investments in tech companies in hopes that the companies will become profitable. The massive speculations result from the current focus on technology, and thus its potential to become highly remunerative in the future.
In a stock market, the price of stock is dependent on the supply and demand of investors, stock prices tend to rise when it seems that a company will earn more in the future. This triggers investors to buy more of the stock, rising the prices even more due to increased demand, creating a feedback loop where investors get caught up in the hype and ultimately drives prices far above the intrinsic value of the company, forming a bubble.
All that is needed for an economic bubble to burst is the collective realisation that the price of the stock far exceeds its worth, the demand ends and prices are pushed to staggering lows. Ultimately, the investors are going all in for an optimistic outcome for the tech companies. If expectations don’t pan out, we can expect share prices to follow suit.
A turning point
The stampede of tech unicorns reveals an important element spanning across industries: technology is here to stay. However, it remains uncertain how many of the companies will survive in the long-term, especially when 15 of the tech unicorns that went public over the past 3 quarters have been charting a cumulative loss of US$6 billion.
It is thus critical for companies to sustain their growth through continuous Research and Development (R&D) in the technological sector, given that new technology could become obsolete in an instant. The failure to live up to the expectations of the investors depreciates the perceived value of a company’s worth in the industry, leading to large withdrawals of investments. The company will then plummet from its status as a rare breed.
The tech-based valuations of today are often based on the future prospects, ideas, and other nebulous concepts. The resulting buzz from these novel ideas raises the perceived value of the companies far above their intrinsic value.
Smaller business should thus arm themselves by reinforcing the foundations of their operations and invest in meaningful and beneficial technology, so as to cushion their fall when the bubble bursts. Partnering with a company that has foresight is also imperative for businesses to tide over the incoming stampede of unicorns.