2015 was the year of the “unicorn” – private technology-driven startups that reached a valuation of $1 billion or more.
But tech and startup investment is going to be defined by a very different beast in 2016 – the cockroach.
“Everything is about resiliency now to weather the storm,” says Tim McSweeney, a director at technology-focused merchant bank Restoration Partners. “Unicorn, it’s a mythical beast, whereas a cockroach, it can survive a nuclear war.”
A unicorn is characterised by superfast growth, fuelled by VC money. They’re not profitable but the idea is that the business will reach “scale” first, before concentrating on making a money once it’s won plenty of market share. Uber is a prime example.
Startups that joined the unicorn club last year include TransferWise, Lyft, Zenefits, SoFi, Hellofresh, Prosper, Oscar, and Farfetch, according to venture capital data tracker CB Insights. There were many more.
A cockroach, by contrast, is a business that builds slowly and steadily from the get go, keeping a close eye on revenues and profits. Spending is kept in check so that it can weather any funding storm.
McSweeney says: “For the investment side, it’s minimizing the risk. Let’s find a company that can survive a nuclear war and then come back to fight another day or pivot and do something different – it has the right team, the right customer base etc.”
McSweeney mentioned the concept of a cockroach company to me at the launch of the Virtual Technology Cluster (VTC) Group recently in London and jumped on the phone later on to discuss it.
Restoration Partners doesn’t invest itself but offers banking services to business-focused technology startups. As such, McSweeney and his colleagues have a good view of the investment space.
McSweeney didn’t coin the term cockroach and isn’t the first to highlight it. The investment theory is an old one and Flickr founder Caterina Fake penned a blogpost on the idea last September.
Unicorns are going out of fashion for many investors.
But the idea of the cockroach vs. unicorn captures a widespread mood in the investment community right now. At a recent conference in London on fintech – one of the hottest subsectors of technology that boasts plenty of unicorns – I found investors and bankers worried about “froth” in the market.
McSweeney says: “I think the unicorn element is coming to an end anyway and the bubble in the market is just sloping off.”
McSweeney’s boss, Restoration Partners’ founder Ken Olisa, told me much the same thing. At the VTC Group launch, he said: “There’s a unicorn industry and they can play around with each other but all it will do is end in tears, because it’s not about the customer and it’s not about adding value to anything.”
So why are investors looking for cockroaches rather than unicorns now? The answer is funding.
2015 was characterised by free and easy funding for startups, thanks to record low-interest rates driving more and more cash into venture capital and poor stock market performance encouraging the likes of Fidelity and BlackRock to try their hand at VC investing.
But 2016 got off to a very different start, with venture capital funding drying up amid wobbles for the global economy.
This has revealed problems in the business models of many unicorns and other fast-growing tech businesses, most of which rely on easy VC money to fund their growth. Businesses like Twitter and Birchbox have all been making layoffs and Fortune’s Dan Primack recently noted that both private equity and venture capital performance declined in the first quarter of 2016 for the first time in years. Zenefits, one of the 2015 inductees to the unicorn club, has imploded pretty spectacularly.
McSweeney says: “In terms of chasing growth and growth and growth – it’s not about sustainability. It’s just trying to grow as quickly as you can without looking at the fundamentals of the house. That’s what I feel a unicorn is – chase growth so investors give you money. It’s kind of a reinforcing cycle.
“Google didn’t growth hack, they just provided a service to the internet and build a business around it.”
He adds: “Look at Powa. It’s the bubble – I wouldn’t say it’s bursting, but it’s sloping downwards. There’s frothiness.”
London-based Powa Technologies raised at least $225 million in debt and equity over the last three years and at one point claimed to be worth $2.7 billion. But the payments business went bust in February, with debts of $16.4 million and just $250,000 in the bank.
McSweeney says: “I still think there’s capital out there but the application of it is more judicious. People are looking for smarter businesses to apply their capital to.”
This article was originally published in Business Insider
Image credit: Reuters/Andrew Kelly