Unicorns Are Rare, So Why Do Investors Hunt Them?

Oh, the siren song of the unicorn! Investors today use the meteoric rise of companies like Meta, or stories about Yahoo! passing on a $1 million Google acquisition, to justify the aggressive pursuit of promising brands.

 However, statistics paint a far more elusive picture of the unicorn — where even with venture capital (VC) backing, aspiring unicorn startups are far more likely to fall than soar.  In fact, around 25-30% of all VC-backed startups ultimately fail.

So, why do investors keep hunting for that mythical financial score?

What Is a Unicorn, Anyway?

You probably saw images of unicorns in storybooks growing up. White, sparkly, and sporting a pointed horn on its forehead, they were as magical and compelling as they were fictional.

In finance, the term ‘unicorn’ means more than it does in fairytales. Technically speaking, a unicorn company is a startup with a valuation exceeding $1 billion. For venture capitalists, unicorn hunting means investing in companies that they think can quickly scale to that point.

These companies are called ‘unicorns’ because they are just as rare as their fairytale counterparts. Hundreds of millions of companies launch each year. A mere couple of thousands (if that) qualify as unicorns.

The Allure of Anecdotes

The discouraging rates of failure are nothing new, but VC firms are nothing if not optimistic. That’s the entire point of their business model: taking a ‘flyer’ on companies with promise. Their line of work requires magical thinking sometimes.

These bets (when they’re made by reputable pros) are backed by data. Due diligence in venture capital is no joke. However, the only reason that data is examined in the first place is because there’s a historical track record of these bets paying off.

We’re talking about companies like Uber, big players who have upended sectors and changed the way we live. The VC firms who got in early with these companies have made billions.

What those stories don’t always acknowledge is what happens after an IPO. Even so, flashy headlines tend to overshadow the retrospective missives about VC gambles on these purported unicorns. VC investments in the US surged by 34.6% YOY in 2024 despite declining deal volume, driven largely by investment in AI. Part of this might be attributable to investors seeking alternative investments in pursuit of diversification. Another part of it is way more basic.

Investors have a fear of missing out, or FOMO. Those headlines are like catnip for the financially ambitious.

Unicorn Spotting Requires Serious Skill

Despite their comparisons, investing isn’t quite the same as gambling. Such metaphors, however, offer a way to understand specific types of investment strategies. VC firms are a great example.

Technically, VC firms bet on the potential profitability of a company. Purchasing a single share in a company on a stock exchange is a bet on that company’s financial future. VC bets, however, tend to be much, much larger than a trade on Robinhood. They also come with additional risks tied to things like liquidity and time horizons.

Similar to its cousin private equity, the stakes in VC investing mandate rigorous due diligence prior to investment. However, VC due diligence can be even more challenging. In many cases, the companies in question are considered ‘disruptors.’ This means that directly correlated data might not be available or reliable.

To this end, unicorn hunting requires a certain amount of excellence that is not quantifiable on a spreadsheet. You need some imagination to extrapolate data from generally related spaces to future revenue potential.

Beyond the Numbers in Unicorn Appeal

Everyone wants to make money. Unicorns make a lot of money for savvy investors. However, there are also reasons for pursuing unicorns in VC that extend beyond dollar signs.

For most people outside of investing circles, name recognition in VC holds little value. To the principal at a VC firm however, name recognition holds the key to attracting substantial and durable inflows from accredited investors.

When a VC sticks the landing on a unicorn bet, the resulting headlines supercharge their credibility. To this end, small failures feel justifiable. After all, failure is always a risk in VC. However, when a VC firm gets it right, the returns to their current investors will attract more investors with deeper pockets, empowering them to make bigger bets in the future and generate even higher returns.

Are Unicorn Bets Worth It?

There is no investor alive who doesn’t wish they’d gotten in early on companies like Amazon or Microsoft. That being said, in their early days, betting on their viability felt sketchy. We didn’t yet understand how technology would transform the way we live.

VC offers a bridge between where we are now and where we could be. Unicorns operate as promising vehicles that can take us there. Finding them, though, can be challenging to say the least.

That doesn’t mean we shouldn’t seek them out. It just means that we should rely less on fairytale plotlines and more on data. Numbers tell an interesting enough story all on their own.

We think you’ll also like:

1. Beginner’s Guide to Venture Capital Investment and Returns
2. The Fine Print on Investing in Venture Capital
3. Beware Venture Capital Unicorns- Risks Look Greater than Potential Rewards

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Real Estate Investing 101
2. Earning Green by Investing Green
3. The Start Up/Small Business Advisor

This article was originally published on May 14, 2023. This article was most recently updated by the Financial Poise Editors.]

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