Opinion: bullish optimism driving ‘unicorns’ actions is more like delirium

Think Jeff Bezos from Amazon.com, Elon Musk from Tesla, Bill Gates from Microsoft, Mark Zuckerberg from Facebook, Larry Ellison from Oracle or Larry Page and Sergey Brin from Alphabet. None of these business founders knew their half-baked ideas would propel them to the ranks of the richest people in the world. The hundreds of thousands of people whose names we haven’t heard from were also unaware that their half-baked ideas would fail.

The great 20th century British economist John Maynard Keynes realized this when he argued that entrepreneurs generally have little hard evidence to guide their decisions:

He noted: “Our knowledge of the factors that will govern an investment’s return in a few years is generally very low and often negligible. If we speak frankly, we must admit that our knowledge base for estimating the performance in ten years of a railway, a copper mine, a textile factory, the goodwill of a patented drug, a Atlantic liner, a building in the City of London, is little and sometimes nothing; or even in five years.

That’s why launching a risky business is often based on boundless optimism rather than cold calculation:

Keynes added: “Individual initiative will only be sufficient when reasonable calculation is completed and supported by animal spirits, so that the thought of ultimate loss which often overtakes pioneers, as experience tells us without any doubt and to them, is set aside as a healthy man sets aside the expectation of death.

The truth is, most new businesses fail. For example, most new restaurants fail before their first anniversary. Almost 80% close within five years. Yet people continue to open new restaurants. More generally, entrepreneurs keep starting new businesses and people keep investing in new businesses – fueled by fragile expectations and wild dreams of finding the next Apple, Google or Facebook. As one underwriter said, “We basically sell Hope, and Hope has been very good for us. “

The president of a venture capital firm estimated the odds of success to be one in 1,000. An SEC study of 500 randomly selected new issues found that 43% were in confirmed bankruptcy, 25% were losing money. money but still afloat, and 12% had disappeared without a trace. Of the remaining 20%, only 12 companies appeared to be solid success stories – just 2% of the companies surveyed.

The new problems are long shots – lottery tickets – and there is a great demand for lottery tickets.

The last few years have seen an explosion of so-called unicorns, startups with pre-IPO valuations above $ 1 billion – which is a lot of money to pay for hopes and dreams, especially if the unicorns have lost. money year after year.

Consider how several prominent unicorns have behaved over their years of existence. Now in its 18th year of activity, the PLTR of Palantir Technologies,
-1.61%
cumulative losses reached $ 6.2 billion while Airbnb’s ABNB,
-2.74%
cumulative losses reached $ 7.2 billion in its 14th year, Snap SNAP losses,
-2.92%
exceed $ 8 billion; Lyft LYFT,
-4.79%
$ 7 billion, and Nutanix NTNX,
-3.20%
$ 5 billion. Recent estimates from WeWork, which has not done an IPO, put its cumulative losses at around $ 10 billion in March 2021. Uber Technologies UBER,
-1.71%
eclipses them all, with cumulative losses currently exceeding $ 23 billion.

The huge losses before the IPO don’t seem to matter much to venture capitalists who put in more funding until investors can be persuaded to buy publicly traded stocks at prices. swollen. Post-IPO losses also don’t seem to have had much of an effect on stock prices. Hopes and dreams slowly die.

The losses are often terribly large compared to the income. In 2020 and the first quarter of 2021, half of the 76 listed unicorns suffered losses greater than 20% of income and a quarter suffered losses greater than 40%. Uber, Lyft, Palantir and Nutanix recorded losses of more than 50% of their revenue. Airbnb’s losses were over 100%. Nonetheless, many of these stocks are preferred by investors.

Venture capitalists aren’t deterred by new startups either. Venture capitalists provided a record amount of funding to startups in the first quarter of 2021, and more unicorns were created in the second quarter of 2021 than in all of 2020.

There was good news. Moderna mRNA,
-4.08%
went from big loser to big winner thanks to its COVID-19 vaccine while GoodRx Holdings GDRX,
-9.74%
(a telemedicine provider), Coinbase Global COIN,
-1.69%
(a crypto exchange) and Corsair Gaming CRSR,

(a games company) each went from small losses in 2019 to profits in 2020 and the first quarter of 2021.

Convinced optimists might argue that Amazon.com AMZN,
+ 0.15%
became profitable after a decade of losses, so why not the others? As America’s biggest money loser among the most successful startups of the past 50 years, Amazon didn’t turn a profit until its 10e year of existence and its subsequent profits covered cumulative losses only from the 16th year. Yet it is now one of the most valuable companies in the world. If Amazon can do it, why not Snap, Airbnb, and today’s other losing unicorns?

Some unicorn startups have enviable track records of profit. Coinbase, Zoom Video Communications ZM,
-1.92%,
PRPL Innovation Violette,
-2.88%,
Etsy ETSY,
-0.86%,
and GoodRX have been profitable or nearly profitable for years, as have financial technology providers GreenSky GSKY,
-2.04%,
OPRT Financial Opportunity,
-1.26%,
and Upstart Holdings UPST,
-1.18%
; SunRun RUN solar installer,
-5.05%
; Roku ROKU digital streaming technology,
-0.28%
; and the ZipRecruiter ZIP job market,
-10.14%.
These companies have never suffered the big losses that Amazon has suffered and they could continue to be profitable for years to come.

What’s troubling is that several unicorns have far exceeded Amazon’s maximum cumulative losses of $ 3 billion, and many more are on the way. Of the 76 publicly traded unicorns, 51 have over $ 500 million in cumulative losses, 27 have over $ 1 billion, 17 have over $ 1.5 billion, and six have more than Amazon’s maximum cumulative losses of $ 3 billion. In total, the cumulative losses of the 76 publicly traded unicorns are well over $ 100 billion, and that astonishing number does not begin to count the losses of the hundreds of private unicorns.

With over 80% of all private unicorns unprofitable in both 2020 and the first quarter of 2021, it will be extremely difficult for most to get out of their deep holes. A more likely outcome is that many will continue to rack up losses.

Still, the market doesn’t seem to care. As of August 16, Snap was valued at around $ 118 billion, Airbnb at $ 94 billion, Uber at $ 80 billion, Palantir at $ 47 billion, and Lyft at $ 18 billion – even though they’re all on the table. on track to add at least $ 1 billion to their existing offering. cumulative losses in 2021. By comparison, Amazon’s market capitalization did not cross the $ 19 billion mark until 2003, after reaching profitability.

Other big losers also have huge market caps. Snowflake SNOW,
-3.21%
as of August 16, was valued at around $ 86 billion, Pinterest PINS,
+ 0.45%
at $ 36 billion, Cloudflare NET,
-1.13%
at $ 38 billion, Zscaler ZS,
-0.70%,
Okta OKTA,
-1.70%,
and UiPath PATH,
-3.18%
each about $ 32 billion, and MongoDB MDB,
-2.73%
to nearly $ 25 billion, although each of them has cumulative losses greater than annual revenues. Even if these startups suddenly made a profit equivalent to 10% of their income, it would take them at least 10 years to erase their cumulative losses. Can investors wait that long – and should they?

What if the U.S. government ended the low interest rates, asset purchases, and other economic stimuli that support these startups? The total market capitalization of public unicorns is now close to $ 1 trillion and the global valuation of private unicorns is around $ 2.5 trillion. What will happen to the US economy if these exuberant market values ​​melt?

Amazon is clearly not a good role model for today’s money-losing unicorns. Most are well over 10 years old, many are over 15 years old, and cumulative losses for many continue to increase with no turnaround in sight. These deep financial sinkholes may never get back what they’ve already lost, or it may take so long that it doesn’t matter. That is, there is a big difference here between optimism and delusion.

Jeffrey Funk is an independent technology consultant and former university professor who focuses on the economics of new technologies. Gary N. Smith is Fletcher Jones Professor of Economics at Pomona College. He is the author of “The AI ​​Delusion” (Oxford, 2018), co-author (with Jay Cordes) of “The 9 Pitfalls of Data Science” (Oxford 2019) and author of “The Phantom Pattern Problem” ( Oxford 2020).

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