SAN FRANCISCO — Hot social media network BeReal — which is gaining steam with young people as a casual alternative to Instagram — recently raised money, a key milestone in the path of any successful start-up.
While a billion dollars may seem like a big bet, unicorn status for years has helped young companies attract employees and media attention, as well as offering founders runway to pursue new ideas and cachet with potential partners. Many now-established start-ups like Airbnb and Uber that have shaken up long-standing industries depended on deep-pocketed investors to cover losses while they struggled to compete.
But BeReal’s experience is representative of a new reality in Silicon Valley.
As a growing number of employee layoffs, CEO resignations and belt-tightening eliminates some of the excessive perks tech companies are known for, investors here minted only 25 companies worth over $1 billion each in the third quarter of 2022, according to venture capital research firm CB Insights. A year ago, there were more than five times as many new unicorns.
The drop is a harsh dose of rationality much needed in an environment that rewards big promises and falls prey to hype, investors said.
“It’s going to get a ton of founders who shouldn’t be doing it out of the ecosystem — people doing it for money and fame,” said venture capitalist Paige Craig, who invested in companies including Twitter and Lyft.
But the shock waves rattling the tech sector could eventually hit innovation and reduce competition in an industry already dominated by Big Tech companies including Apple, Google, Facebook and Amazon.
As interest rates spike and concerns over a global recession send shudders through the economy, tech companies big and small are slowing hiring and cutting new investments. Google’s CEO has implored his workers to show “more hunger,” and thousands of start-up employees have lost their jobs over the past six months. Stock prices for tech companies — which marched ever upward over the last decade — have finally fallen back to earth. The Nasdaq 100, an index representing the biggest public tech companies, is down 30 percent this year.
Meanwhile, investors have yet to find the next big technological innovation to transform the way we live. While unicorns in theory represent the moonshot ideas that will help Silicon Valley land on the next big thing, billions funneled into crypto, Web3, and virtual reality haven’t yet taken off.
Once-prolific investors like the venture firm Andreessen Horowitz, which invested in BeReal’s first funding round, have pared back their investments. The amount of venture capital funding going into late-stage start-ups fell nearly 50 percent in the third quarter compared to the second quarter, according to venture capital research firm PitchBook Data. Already, some are bracing for a cultural shift from abundance to survival mode.
More than a decade ago, the $1 billion unicorn start-up became an aspirational marker of success in Silicon Valley. It reflected the exuberance and optimism of a near-mythical bastion of the economy where the boom times never seemed to end.
Investors agree to commit a certain dollar amount of funding to a start-up to help it get off the ground in exchange for a stake in the company, with the expectation that it will eventually go public or get acquired. The valuation is calculated by how much an investor pays for a stake — for example, a 10 percent stake at $100 million would value a company at $1 billion. But the price tag is all on paper, and there is no guarantee the company will ever be worth that amount.
The term unicorn was coined in 2013 by venture capitalist Aileen Lee and was meant to denote the fact that a start-up that crossed that threshold was extremely rare. No other concept so neatly embodied the magical thinking that fueled sky-high valuations based not on real revenue or profit but simply on a company’s ability to keep growing.
The stock market was still struggling following the 2008 financial collapse, and start-up founders increasingly chose to stay private instead of going public and listing on the stock exchange, accepting big checks from venture capital firms who offered favorable terms without the volatility of stock price trading.
“That is what gave rise to unicorns,” said Sebastian Mallaby, author of The Power Law, about the rise of the venture capital industry.
Many of those companies never lived up to the spectacular expectations thrust upon them. At one point, office-sharing company WeWork was valued by its investors at $49 billion, but it now trades publicly on the stock market at less than $2 billion. Blood-testing company Theranos was valued at $10 billion at its peak. In January a jury found its founder Elizabeth Holmes guilty of defrauding investors.
Still, the concept of the unicorn became a lasting one in Silicon Valley, and companies that could command big valuations attracted the best employees and investors.
Venture firms, who invest money in young companies hoping to reap major rewards down the road, have historically made the biggest returns on just a few of the many firms they invest in. Those that succeed are generally founders who promise big potential upside, rather than steady profits and sustainable growth.
That growth-at-all-costs mentality helped companies like Facebook, Google and Amazon become the dominant firms they are today. For years, those companies were relatively unprofitable, instead reinvesting in their businesses. But eventually, they became some of the most valuable companies in the world, turning early investors who stuck with them into billionaires. (Amazon founder Jeff Bezos owns The Washington Post.)
The massive amounts of money being made once companies went public attracted even larger investors to venture capital, including pension funds, sovereign wealth funds and private equity giants.
In 2021, new unicorn companies were being created at a rate of more than two per business day, according to CB Insights, becoming almost commonplace.
But as governments pushed up interest rates this year to stave off inflation, big investors such as pension funds and sovereign wealth funds abruptly left the venture capital market to focus on less risky and long-term investments, said Kyle Stanford, a senior analyst with PitchBook Data.
“There’s not enough capital to really make investments that are going to create unicorns,” Stanford said.
And as public company stock prices dropped, the private markets followed.
BeReal did not respond to requests for comment. There are additional reasons it may have raised capital at a lower rate, including the fact that brands have struggled to use its service, or that TikTok and Instagram have already copied the app’s sole feature.
Some existing unicorns have already had to do layoffs, and others have been acquired in fire sales.
Brex, a financial tech company which raised money in January at a valuation of more than $12 billion, laid off 11 percent of its staff earlier this month. BlockFi, which had been valued at $4.5 billion, was acquired by FTX, another crypto company, for $240 million.
Bird, the e-scooter start-up, was once valued at $2.85 billion as investors poured money into companies that mimicked Uber’s model for revolutionizing transport. It became publicly traded last year and is now worth $89 million.
One of the biggest effects likely to hit consumers is an increase in prices.
Tech start-ups from Uber to Amazon long subsidized prices to help ensure faster growth. Even if they eventually raised prices, other start-ups with new money often came along with their own subsidized products as they fought their way into crowded markets.
Now that dynamic may be less common. Consumers used to low fees on food delivery or free returns on direct-to-consumer glasses and mattresses may see those options disappear.
There are still exceptions to the gloom. Artificial intelligence start-ups are garnering a lot of interest and funding, as several tech breakthroughs in the field lead to a wave of excitement. Stability AI, which has released software to the public that can create elaborate images from simple text prompts, raised more than $100 million at a $1 billion valuation according to Bloomberg News.
WeWork founder Adam Neumann, who became emblematic of unfounded Silicon Valley hype, recently netted a $350 million investment and $1 billion valuation for his new real estate start-up, which plans to offer a branded product with community features in the housing rental market.
In his 2022 book, Mallaby warned about the unicorn bubble that started to form in 2016 when outsiders to late stage investing began writing enormous checks. Start-up founders were treated like “emperors of the operation,” he said, with little oversight.
The drop in unicorns could signal less excess money in the growth phase, and a check on unicorn founders “when their hubris turns toxic,” Mallaby said.
Touraj Parang, an adviser at Pear VC and author of start-up guide Exit Path, also said the drop in new unicorns is a sign of rationality, and that start-ups able to raise funding will probably have to do it at a lower valuation than their previous round.
Others are skeptical. Investor Del Johnson said Silicon Valley can’t change its spots.
“When they talk about concepts such as fundamentals and rationality, investors are merely gesturing to the conventional wisdom, which is itself based on consensus, not accurate financial math,” he said. “Venture capital has never been a ‘rational’ asset in the first place, so there can be no return to rationality.”