Tag: unicorn

Game of loans

In my article on start-up unicorns, I already presented how most start-ups finance their operations and how efficient this way of work is. This article will show how companies and wealthy individuals finance their operations once they reach unicorn status and have already managed to execute a successful IPO or ICO.

But before explaining the financial workflow, let’s analyze what an IPO is and how it integrates with the standard capitalism-based system. At its core, IPO operates the same way as every ordinary bank. People trust the company doing IPO and are willing to buy common stocks of this company. Additionally, let’s analyze a little bit how banks evaluate a given company to calculate its value. Usually, it is a combination of all of its assets, including the common stocks from the stock exchange. So far, so good; however, the stock exchange evaluation rules are pretty exciting. More specifically, the rule of how the end-of-day price calculation is done. It is based on the amount of money an individual is willing to pay for a given stock. And here is the part that must bother us – one big chunk of a given company evaluation is entirely based on people’s trust in the company. It is not based on any real-life assets such as gold, art, or real estate. It is entirely based on faith. We can even safely assume that we ll are living in a trust-based economy.

On the diagram, you can see a standard way of how wealthy individuals finance their operations. They use the IPO/ICO to increase their liquidity and apply for a loan after that

But let’s go back to loans – how do we calculate the personal wealth of people. The answer is a simple one. The same way banks calculate the evaluation of a company – aka based on all personal assets, including stocks. When wealthy individuals decide to buy something or invest in something, they have two ways of doing that – to sell assets or to get a loan.

Usually, most of them are willing to get a loan based on the current evaluation of their stocks and payback later. However, to give the loan, the bank does the review based on the willingness of someone to buy the stocks at a given price. In traditional banking, this usually triggers the central banks to issue a new amount of the local currency to provide the bank with the amount of money necessary to give the loan. So, in short, every time the bank provides a loan based on stocks, we pump new money into the system and lower down the buying power of everyone attached to the local currency.

In conclusion, most wealthy individuals prefer to finance their operations using loans instead of selling stocks at the current value. However, getting a loan increases inflation because the central banks have to issue new money to fund these loans. Another question is how much is the buying power of our modern billionaires compared to the ones in the past. For sure, most of them can not afford to finance the operations of over 1000 public libraries with their own money.

We live in а bubble world, full of unicorns

If we can use one sentence regarding the startup culture for the past decade, it will be Bubbles and Unicorns everywhere. These days every entrepreneur is trying to create the next unicorn and to fill its bubble with money. Unfortunately, looking at the facts, this approach is unsuccessful and usually leads to the startup’s failure. 

But let’s analyze the definition of the unicorn in the startup culture – the unicorn is a startup with an evaluation of over 1 billion US dollars. Here is the essential point of our analysis. Evaluation is not the annual profit these companies are making. We could define evaluation as the “social” trust into a global brand, and we “evaluate” this “social” trust to 1 billion US dollars. Last year’s report showed that from 73 unicorn companies, only 6 had a positive net profit. And to make the situation even worse, 34 of these 73 unicorns had losses more significant than 30% of their revenue.

Having the previous paragraph in mind, we could easily deduce that without a proper IPO, these 34 unicorns would most probably end with a failure. Furthermore, the six profitable Unicorn startups (out of 73) did IPOs many years ago. No Unicorn startup among those announcing or doing an IPO since Zoom in August 2019 was profitable in 2019 (or 2020). The statistic suggests that the privately held Unicorns, which have yet to do IPOs, are primarily unprofitable. Thus, the record low profitability of startups is likely to get worse. 

On the diagram, you can see a standard workflow of the making of a unicorn startup. In every round, more and more companies decide to exit, or they fail. Others manage to attract new funding and continue until they reach the dreamt status of the unicorn

And here is one exciting statement – every IPO company acts as an investment bank. It needs the IPO investors’ money to fund its activities. However, we need to ask ourselves whether this is a sustainable approach and whether we should mark unicorns as “successful” business ventures, considering that they do not operate on profit. And here is a sample list of reasons, marking unicorn as successful is a bad idea:

  • No net profit from their main business idea: Making not enough profit from their business idea means that the business idea is not viable. Evaluation of 1 billion US dollars does not mean that the assessment of the concept is so much.
  • Need of IPO to survive: Going into IPO mode means that the unicorn is now a public investment bank. In that sense, it starts acting as a bank, but not as a business venture. Another hint that the business idea was not profitable enough.
  • The considerable margin between evaluation and revenue: Sometimes, there is a significant margin between profit and revenue. It is essential to understand that evaluation is based on mathematical formulas, and as with every formula, the results can be set up for enormous evaluation. So, in short, a significant evaluation does not mean a successful business idea.

In conclusion, I think it is suitable for every entrepreneur and investor to ask themselves whether it is good to operate a business this way. Maybe a more prudent approach to doing business and ensuring the company has a minimized positive net profit will make the startup environment much better and less stressful.