Veteran venture capitalist Aileen Lee was candid about a significant effect of the recent boom-and-bust cycle in this week’s StrictlyVC Download podcast episode: many companies that are in limbo are not only having trouble getting back on their feet after raising excessive funds at unsustainable valuations, but they have also lost the champions who once supported them.
Lee talked about how limited partners are reluctant to criticize influential fund managers for fear of losing their ability to participate in those companies in the future. However, she pictured what they might say if they had unrestricted speech:
“They never criticize them [for fear of consequences] because everyone wants to invest in X brand name fund. They probably talk about us behind our backs [laughs].” They would argue, however, that “all the people who have [were] hired at these venture firms during the ZIRP era… they made a bunch of crappy investments” and that they are now being pushed out, but it’s too late, Lee noted. “The venture job holders didn’t stay long enough to see whether the businesses were successful, so all [the LPs’] money essentially just went down the drain.”
Lee went on to say that these more recent investors are not to blame. As a result, “many people were given checkbooks, no mentorship or apprenticeship, and no training, and a lot of investments were made, and… there are a lot of orphaned companies.”
Another factor, however, is that startups are being left on their own, “and I find this crazy,” Lee added. Frequently, a more senior general partner “who led the investment – who is still there [at the firm] but just stopped showing up to the board meetings” has abandoned the company.
At this time, it has been occurring for years for some companies. When it came to these same investments, the corner cutting never completely ceased, and no one conducted as much due diligence during the go-go Covid era of finance. However, it’s also a major factor in why more businesses are having trouble getting outside assistance for exit strategies, which is why LPs have good reason to express their anger.
When VCs first ceased attending the board meetings of businesses that were losing steam in late 2022, another veteran VC, Jason Lemkin, told this editor: “[S]houldn’t there be checks and balances? You are sort of releasing part of your fiduciary duties to your LPs when you don’t undertake due diligence on the way in and at a board meeting, since pension funds, colleges, widows, and orphans have invested millions and millions of dollars.
The Unicorn Dilemma: How the Investor Exodus is Deepening Challenges for Startups, According to VC Aileen Lee
In the fast-paced world of venture capital and startups, unicorn companies—privately held startups valued at over $1 billion—have long been the crown jewels of innovation and growth. However, the landscape is shifting, and not in favor of these once-celebrated entities. Aileen Lee, the renowned venture capitalist who coined the term “unicorn,” has recently shed light on a growing concern: the broader investor exodus is exacerbating the challenges faced by these high-value startups.
The Golden Era of Unicorns
The last decade witnessed an unprecedented rise in the number of unicorn companies. Fueled by easy access to capital, low interest rates, and a bullish market, startups across sectors like tech, fintech, and biotech achieved billion-dollar valuations at a rapid pace. Investors were eager to pour money into these companies, betting on their potential to disrupt industries and deliver outsized returns.
However, as Lee points out, the tide is turning. The economic environment has become increasingly uncertain, marked by rising interest rates, inflationary pressures, and geopolitical tensions. These factors have led to a significant pullback in venture capital funding, creating a ripple effect across the startup ecosystem.
The Investor Exodus: A Perfect Storm
Lee highlights that the current investor exodus is not just a temporary blip but a reflection of deeper systemic issues. Here’s how this trend is worsening the woes for unicorn companies:
- Drying Up of Capital: With investors becoming more risk-averse, the flow of capital to unicorns has slowed dramatically. Late-stage funding rounds, which were once abundant, are now harder to secure. This leaves many unicorns struggling to maintain their growth trajectories or even stay afloat.
- Down Rounds and Valuation Cuts: As funding becomes scarce, unicorns are increasingly facing down rounds—raising money at lower valuations than previous rounds. This not only dilutes existing shareholders but also damages the company’s reputation and employee morale. Lee warns that this trend could lead to a vicious cycle, where lower valuations make it even harder to attract new investors.
- Increased Scrutiny on Profitability: In the past, investors were willing to overlook losses in favor of growth. Today, the focus has shifted to profitability and sustainable business models. Unicorns that relied on burning cash to acquire market share are now under pressure to demonstrate a clear path to profitability—a challenge many are ill-prepared to meet.
- Talent Retention Challenges: The uncertainty surrounding funding and valuations is also impacting employee retention. Stock options, once a major draw for top talent, are losing their allure as the likelihood of a lucrative exit diminishes. This makes it harder for unicorns to attract and retain the skilled workforce they need to innovate and grow.
The Road Ahead: Navigating the New Normal
While the current environment poses significant challenges, Lee believes that not all is lost for unicorn companies. She emphasizes the importance of adaptability and resilience in navigating this new normal. Here are some strategies that could help unicorns weather the storm:
- Focus on Unit Economics: Startups need to prioritize unit economics and demonstrate that they can generate profits on a per-unit basis. This will not only make them more attractive to investors but also ensure long-term sustainability.
- Diversify Revenue Streams: Relying on a single revenue stream is risky in an uncertain market. Unicorns should explore diversifying their revenue sources to reduce dependence on any one market or product.
- Strengthen Corporate Governance: Strong governance and transparent communication with stakeholders can build trust and confidence, even in challenging times. This includes being upfront about challenges and outlining clear plans to address them.
- Leverage Strategic Partnerships: Collaborating with established players in the industry can provide unicorns with the resources and market access they need to grow, even in a tight funding environment.
Conclusion
The unicorn phenomenon has been a defining feature of the startup ecosystem over the past decade. However, as Aileen Lee highlights, the broader investor exodus is creating significant headwinds for these companies. While the road ahead is fraught with challenges, it also presents an opportunity for unicorns to reassess their strategies, focus on fundamentals, and emerge stronger in the long run.
In a world where the only constant is change, adaptability and resilience will be the key to survival. For unicorns, the message is clear: evolve or risk becoming a relic of a bygone era.