Some recent signs indeed point to further declines in the fortunes of unicorns. In the final quarter of 2015, a wave of multi-million-dollar write-downs by asset management firms hit companies including Dropbox and MongoDB.1 Now, in mid-2017, the US$68.5bn valuation of Uber appears to be at risk as well: Three investor groups want to put money into the ride-hailing company, but at an undisclosed discount price.2

One of our respondents, a Texas-based managing director at a mid-market investment bank, said this reversal was inevitable given the inflated valuations held by many unicorns. “The mindset towards the unicorns is changing now as we see financing decreasing for them,” the investment banker said.

1 What will happen to the valuations of unicorns in the next 12 months?The once-vaunted category of unicorn companies is losing some of its sheen. In 2014, more than 30 private companies worth US$1bn or more exited, and the average exit valuation rose to above US$9bn, according to data from CB Insights. In the following two years, 25 or fewer unicorns exited each year and the average exit price fell to below US$3bn.

Looking forward to the coming 12 months, more than two-thirds (68%) of our respondents believe the valuations of unicorn companies will continue to decline somewhat. Twelve percent think they will remain the same, while one-fifth (20%) think valuations will rebound and actually increase somewhat.

M&A Pulse

Unicorns Investor sentiment toward the class of private companies worth US$1bn or more begins to shift

1. https://www.ft.com/content/9312e100-f71c-11e5-803c-d27c7117d132 2. https://www.nytimes.com/2017/08/13/technology/uber-board-considers-3-investment-offers-to-buy-companys-shares.html?mtrref=www.bloomberg.com

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steadily improve and growth rates start rising, we expect a change to take place and unicorn companies to gain value. The valuation of unicorn companies will also increase because investment options are limited and unicorn companies promise strong value and earnings for investors.”

2 Which regions are likely to see the most new unicorns appear in the next 12 months? (Select top two)The United States currently dominates the globe when it comes to unicorn companies. It has 107 privately owned firms valued at US$1bn or more – more than the rest of the world combined (103). However, the surging economies of China and India are rapidly breeding new unicorn stock. There are now 54 such companies in China and 10 in India, nearly all of which have appeared in the last four years.

As a result, it should come as little surprise that our respondents believe these two regions will continue to produce the most new unicorns. Eighty-eight percent said they think North America will be among the top two regions with the most new unicorns in the next 12 months, and 68% said they think Asia-Pacific will be in the top two regions for such companies. Just 44% believe Europe will have the most new unicorns.

“Many investors are unwilling to pump more capital into unicorns, since many of them are losing value. This was bound to happen, as a lot of unicorns had a valuation much higher than their potential warranted and it was never going to be easy to sustain.”

Another sign of unicorns’ declining fortunes has been the fall in the stock prices of recently listed companies Snap and Blue Apron. The value of social media giant Snap dropped by 53% as of mid-August from its first-day price earlier this year, and that of meal kit service Blue Apron had gone down by 42%.

However, not everyone is so pessimistic on the valuation front. A managing director at a Bay Area-based private equity firm noted that the overall stock market has performed exceptionally well, creating fertile ground for further IPOs.

“The value of unicorn companies will slowly increase,” the PE managing director said. “As equity markets

Number of companies that exited Average exit valuation (US$bn)

Num

ber

of c

ompa

nies

that

exi

ted A

verage exit valuation (US

$bn)

0

5

10

15

20

25

30

35

YTD2017

201620152014201320122011201020090

2

4

6

8

10

*Source: CB Insights

North America88%

Europe44%

Asia-Pacific68%

Latin America0% Unrecorded

Unicorn exits, 2009 - YTD 2017*

2

20%

68% 12%

Increase somewhat

Remain the same

Decrease somewhat

1

Unicorns I 3

Unlike many of the largest private American companies, most of the Chinese unicorns are not household names globally, since they primarily serve a domestic audience. However, China’s enormous population has spawned some true giants, such as ride-hailing firm Didi Chuxing (US$50bn valuation) and peer-to-peer lending platform Lufax (US$18.5bn valuation). In India, the largest unicorn is online store Flipkart (US$11.6bn valuation), which has more than 38% of the country’s online shopping market share.3

Several fast-growing Asian startups are producers of innovative technology as well, such as Chinese facial recognition software developer SenseTime (US$1.5bn valuation).4 One of our respondents, the managing partner at a technology-focused private equity and

venture capital firm, said many more such firms are expected to appear in the region.

“China, India and other APAC markets are very important – a large number of unicorns are expected to rise there, with the advancement and development of technologies that cater to different sectors,” the managing partner said. “A push by certain Asian governments to create a capital pool that companies can tap into in their initial stages has also helped companies grow and achieve the threshold valuation of over US$1bn.”

One advantage held by US companies is ample access to venture capital funding, since many funds are based in North America. Overall in 2016, VC investment in the Americas stood at US$72bn, compared to US$39bn in Asia and US$16bn in Europe, according to a KPMG report.5

“In North America, companies have managed to grow at a very quick pace because of the capital they have received,” said a managing director at one of the top 20 global alternative asset managers. “The availability of investors in the form of PE and VC firms has helped companies grow and expand successfully.”

3 Which unicorns are most likely to be bought or go public in the next 12 months? (Select up to three companies)Unicorns are, by their very nature, likely to be sold or go public at some point in their life spans, in order to provide their investors and founders a return on their

“China, India and other APAC markets are very important — a large number of unicorns are expected to rise there."

Managing partner at a technology-focused private equity firm in the US

South Korea

Germany

UnitedKingdom

India

China

UnitedStates 107

54

10

9

4

3*Source: CB Insights

Number of unicorns by country, as of August 2017*

3. http://economictimes.indiatimes.com/small-biz/startups/how-flipkart-has-fared-against-amazon-india/articleshow/60069546.cms 4. https://www.wsj.com/articles/saving-face-investment-in-recognition-technology-heats-up-in-china-1499763603 5. https://assets.kpmg.com/content/dam/kpmg/xx/pdf/2017/01/venture-pulse-q4-2016-report.pdf

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investment. However, identifying the right moment to conduct the transaction can be extremely difficult.

Earlier this year, many observers thought the window for IPOs was wide open after Snap and Blue Apron both pulled the trigger on their offerings in March and June, respectively. But after both underperformed compared to their initial offering prices, companies and investors alike have become more wary about new debutants.

Nonetheless, several unicorns are strongly expected to go public or otherwise make an exit in the upcoming year. The greatest percentage of our respondents pointed to Spotify (68%), Dropbox (36%), Robinhood (32%), and Palantir Technologies (32%) as the companies most likely to give up their unicorn status.

Spotify, which currently has a valuation of US$8.5bn, is predicted to debut by late 2017 or early 2018, according to news reports.6 The music streaming service is considering a direct listing instead of a traditional IPO, which would allow its equity holders to exit their stakes without a holding period, but would forgo the boost to the stock price typically provided by Wall Street underwriters. Spotify had sales of US$3.09bn in 2016 but reported a net loss of US$568m.7

A managing director at a private equity firm with over US$15bn in committed capital said both Spotify and WeWork, the co-working company with a US$20bn valuation, should move toward an exit soon.

“Spotify and WeWork need to carry out IPOs – they are well evaluated and performing strong,” the PE managing director said. “There is talk of these companies getting listed soon, and this decision will likely be backed by their management in order to expand and develop by getting access to capital. Both of these companies have a strong base of customers, making them prime targets for investors.”

Another one of our respondents singled out vacation rental service Airbnb (US$29.3bn valuation) and Chinese P2P lender Lufax (US$18.5bn valuation) as likely candidates for exits given the favorable sentiment surrounding them and their high worth. Airbnb has faced local regulatory hurdles in many cities but continues to grow, reaching four million listings in August – more than the total held by the world’s top five hotel brands combined.8 “I cannot say

ANT Financial

Lufax

Pinterest

Flipkart

WeWork

Uber

Airbnb

Palantir Technologies

Robinhood

Dropbox

Spotify 68%

36%

32%

32%

28%

28%

24%

16%

12%

12%

12%

3

6. https://www.cnbc.com/2017/05/12/spotify-direct-listing-on-nyse-in-2017-or-early-2018-sources.html 7. http://www.billboard.com/articles/business/7841155/spotify-financial-analysis-profitability-ipo 8. http://www.businessinsider.com/airbnb-total-worldwide-listings-2017-8?r=UK&IR=T

Unicorns I 5

for sure which companies will exit next, but Airbnb and Lufax are valued very highly,” said a managing director at a growth equity firm with more than 10 offices worldwide.

4 Which sectors will see the most M&A activity involving unicorns in the next 12 months? (select the top two)An overwhelming proportion of the unicorn companies are technology-driven enterprises. Within the technology category, however, not all sub-sectors have equal representation. The segment with the greatest number of unicorns at present is e-commerce with 34, followed by internet software & services with 27 and fintech with 25. The e-commerce unicorns include Indian shopping website Snapdeal (US$7bn valuation) and US sports apparel retailer Fanatics (US$4.5bn).

When it comes to M&A activity, the largest percentage of our respondents (48%) think fintech will be one of the top two sectors for deals, followed by e-commerce (44%), cloud computing (36%), and big data (32%). A smaller proportion believe that companies in healthcare (24%) and social media (16%) will see the most transactions.

Some of the most headline-grabbing deals of recent years have been in the e-commerce sector, such as Petsmart’s US$3.3bn acquisition of online pet food seller Chewy in April 2017 and Walmart’s US$3.3bn bet on discount shopping site Jet.com in August 2016. And interestingly, despite respondents’ expectations of activity involving fintech targets, there have been only a handful of deals for fintech unicorns over the last three years. Two of the most prominent fintech firms to exit recently did so by going public instead of being acquired: mobile payments giant Square IPOed with a US$2.9bn valuation in November 2015 and embattled business loan provider OnDeck Capital debuted with a US$1.3bn valuation in December 2014.

The CFO of one unicorn company in the medical sector argued that fintech and healthcare companies will be targeted by buyers as they run out of ways to

Cloud computing36%

Social media16%

e-commerce44%

Healthcare24%

Big data32%

Fintech48%

4

Mobile Software& Services

Cybersecurity

Hardware

Big Data

Social

On-Demand

Healthcare

Fintech

Internet Software& Services

eCommerce/Marketplace 34

27

25

17

11

10

10

8

8

5*Source: CB Insights

Number of unicorns by sector, as of August 2017*

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innovate and expand. “M&A activity for healthcare and fintech unicorns is going to increase, as these companies have received a lot of capital but have not managed to sustain the growth rates needed by them to keep their valuations high,” the CFO said.

5 What will be the biggest drivers of unicorns going to market in the next 12 months? (Select top two)Many unicorn companies rise to their impressive status thanks to a relentless drive to grow. And indeed, nearly half of our respondents expect this driver in particular – the need for capital to fuel growth – to push unicorns to seek additional funding in the next 12 months.

One extreme example of this can be seen with Chinese news aggregator Toutiao, which is one of the fastest-growing unicorns in the world. It currently has an US$11bn valuation after being worth just US$500m three years ago, and it has powered this expansion in part through major fundraising rounds. In early August, it was reported that Toutiao would tap fundraising markets once again for at least US$2bn at a US$20bn valuation.9

An extended runway is also important given the fierce competition many unicorns face from established companies. Take the case of Slack Technologies (US$3.8bn valuation), maker of the popular Slack messaging app. There is a large market of software for collaboration and secure messaging, including from incumbents such as Microsoft. In order to keep pace, Slack went to market in late July to raise US$250m, in a round led by Japanese technology conglomerate SoftBank.10

Venture capital funding by large corporates is rising in popularity as legacy companies seek ways to remain on the cutting edge, one of our participants said. “Corporates are approaching unicorns and seeking business ventures by acquiring stakes through mezzanine investors and by buying out PE or VC stakeholders’ shares in the company,” said a managing director at a major US boutique investment bank.

Another major driver of unicorn exits will be excessive debt, according to 40% of our respondents. In 2016, Uber11, Airbnb12 and Didi Chuxing all issued US$1bn or more in debt, and venture debt is becoming more commonplace for later-stage startups.

“Unicorns need continuous capital, because most of them are still far from generating enough revenue to meet their expenses."

Managing partner at a Los Angeles-based private equity firm

High valuations

Corporatesseeking bolt-ons

Equity holdersseeking exits

Low IPOsupply compared

to demand

Excessive debt

Need for capitalto fuel growth

48%

40%

36%

32%

24%

24%

5

9. https://www.reuters.com/article/us-china-toutiao-fundraising-idUSKBN1AR0DE 10. https://www.reuters.com/article/us-slack-fundraising-idUSKBN1AC05J 11. https://www.wsj.com/articles/uber-raises-1-15-billion-from-first-leveraged-loan-1467934151 12. https://www.recode.net/2016/6/15/11951368/airbnb-raised-one-billion-debt-financing

Unicorns I 7

In many cases, respondents said, an IPO is the way these companies will restock their war chests. “Unicorns need continuous capital, because most of them are still far from generating enough revenue to meet their expenses,” said a managing partner at a Los Angeles-based private equity firm. “When private investors show reservations about giving more capital, an IPO is the best choice to raise it.”

6 What will be the biggest risks or challenges to unicorns going to market in the next 12 months? (Select top two)A common point of contention between startup founders and investors is the importance of a young company’s pace of growth versus its profitability. Certainly a company must be strong in one or the other category to be considered successful and attain a high valuation. The highest percentage of our respondents argued that a failure to meet growth expectations (44%) would be among the top two challenges facing unicorns going to market in the coming year, and 40% said a lack of profitability would be among the top two.

These two issues are not always so critical for startups; but in the current overheated environment, they have clearly become essential for investors. Some prominent unicorns have reported dismal profitability figures, prompting observers to wonder about their valuations going forward. Uber is a prime example – the top unicorn had net losses of US$2.8bn in 2016 on net revenue of US$6.5bn.13

Snap is also looking like a cautionary tale to some. After going public in March, it reported in Q2 2017 that its user growth rate fell from 5% to 4.2%, and the company lost US$443m, or almost four times its loss from the same period a year ago.14

“Unicorns have failed to meet their expectations in terms of performance and revenues,” said a partner at a US alternative asset manager with over

US$100bn in assets under management. “Along with these problems, there are internal issues that are wreaking havoc at certain companies and can negatively affect the capital unicorns can raise. These issues can lead to lower valuations for unicorns.”

Roughly a third of our respondents also expect further valuation markdowns by equity holders (36%) and market volatility (32%) to negatively affect unicorns attempting to go to market. US equity markets had experienced a historically long period of stability and growth in 2017 until mid-August, when they saw multiple major declines in quick succession.15

One of our respondents, the head of corporate development at a fintech unicorn, argued that instability such as this will cause problems for companies considering an IPO. “The market is still volatile now, which will directly affect the IPO performance once it lists,” he said. “Unicorns have generally failed to meet growth expectations. Because of this, unicorns are considered vulnerable.”

Geopoliticaluncertainty

Poor performance ofrecent unicorn IPOs

Founders’ desireto retain control

Market volatility

Valuation markdownsby equity holders

Lack of profitability

Failure to meetgrowth expectations 44%

36%

40%

32%

24%

8%

16%

6

13. https://www.bloomberg.com/news/articles/2017-04-14/embattled-uber-reports-strong-sales-growth-as-losses-continue 14. https://techcrunch.com/2017/08/10/snapchat-earnings-q2-2017/ 15. https://www.wsj.com/articles/investors-grapple-with-signs-of-unrest-1503237600?tesla=y

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