Commentary: The curious case of slick start-ups that tout billion-dollar valuations then rapidly collapse
The move-fast-and-break-things tech industry is littered with examples of start-ups that became the darling of the moment, yet months later collapsed into nothing, says NUS Business School’s Low Tuck Kwong Distinguished Professor of Finance Sumit Agarwal.
SINGAPORE: In the middle of last year, two of the biggest names in bike sharing, Ofo and Mobike, were grabbing headlines with valuations topping US$2 billion. This put them squarely among the ranks of the so-called “unicorns” – start-ups with a value over a billion dollars.
What a difference a few months makes.
Now, as we witness the bike-sharing boom fizzle, both firms are in spectacular retreat, maybe near total collapse. Ofo is on the verge of declaring bankruptcy while Mobike recently announced it was quitting Singapore and most of its other Asian ventures, retreating to its home market in China to lick its wounds and try to consolidate.
So, what happened? How did firms recently “valued” highly see that value evaporate so quickly?
MOVE FAST AND BREAK THINGS
It’s an issue that is not confined only to bike-sharing. The move-fast-and-break-things tech industry is littered with examples of start-ups that became the darling of the moment, drawing multi-billion dollar valuations, yet months later collapsed into nothing.
Most of these failures occurred not because of some act of god or other unforeseen misfortune, but because of fundamental problems with either the firm’s business model or its capabilities – factors that you might think would be central to determining its value.
Of course, on the flipside we have also seen many highly-valued start-ups that have lived up to their valuation. Some have gone on to deliver solid, or even outstanding performance. Yet in some ways these successes only add to the confusion.
This raises obvious questions about what meaning such valuations really have. Indeed, do valuations have any real “value” to them?
Look back a few decades and valuations of firms used to be based on tangible hard facts – costs, output of products, sales and cash flows. So what dictated the valuation was the flow of money.
The tech boom has changed much of that.
THERANOS, FRAUD AND SECRECY
Today valuations are frequently based on ideas, inspiring or compelling stories, and on other often nebulous, hard-to-grasp concepts. Often a firm’s purported “value” is the result of bagging attention, capturing eyeballs, and visions - glitzily presented by the firm’s founders - of how some new revolutionary software or device will be perceived.
Putting it differently, it is based on expected growth of the company - yet, time and again we have seen the expected never materialise.
One stark example of an overblown valuation is the now defunct California-based biotech firm Theranos, the story of which is the subject of a recent HBO documentary.
Launched by Stanford dropout Elizabeth Holmes, Theranos attracted more than US$700 million in funding on a promise to revolutionise preventative medicine using a compact in-home bloodtesting machine called the Edison. Theranos and its founder gave slick presentations and attracted huge media coverage, luring in many high-profile investors.
The firm was touted by some as ”the Apple of healthcare” and Holmes even went as far as copying Steve Jobs clothing choices by sporting his trademark black polo neck.
At its peak in 2014, the firm was valued at more than US$10 billion.
But a year later a newspaper investigation exposed the truth behind the company’s “breakthrough” technology. Behind all the hype, and behind a wall of secrecy, it was using routine medical equipment to carry out tests that were supposedly done by its Edison machine.
Theranos rapidly collapsed and the firm’s founder and senior executives now face a raft of fraud charges.
BEWARE THE NEXT BIG THING
Now, by no means are all overvalued start-ups as potentially fraudulent as Theranos. Neither are all failed, formerly highly valued firms, necessarily criminal. But the case sends a cautionary message about valuations and the conditions that can fuel them.
One important factor has been a decade of near zero interest rates, leading to a mountain of excitable investor cash eager to find “the next big thing”.
Fed by gushing headlines about soaring valuations, this frenzy has led to a “get big fast” approach to business development, based on a race to build market share and a blind faith that overlooks or obscures key fundamentals such as revenue growth.
This has produced an ecosystem of unicorns, none of which have to reveal detailed results, talk to analysts or open their books because they haven’t gone public. As a result transparency has plunged and the potential for outright fraud, as was seen with Theranos, is much higher.
READ: Singapore start-ups should solve problems, not focus on achieving 'unicorn' triumphs, a commentary
OVERHYPED INVESTMENTS NOTHING NEW
Of course, overhyped investments are nothing particularly new. The Dutch had their own experience with the tulip craze back in the seventeenth century. But in the scenarios we see playing out today, technology has played a major role in fuelling the scope, speed and scale at which the hype spreads.
In the boom-to-bust tale of bike sharing, many firms built their business models on the promise of vast amounts of supposedly valuable data they would collect about users.
Riding on the back of slick, social media-driven marketing campaigns, they raced to build market share, flooding cities with bikes which were too cheap, too heavy and unreliable, and too poorly maintained to build any kind of loyal user base. They also failed to anticipate the regulatory backlash from authorities fed up with the rash of bikes littering their streets.
On top of this, firms were unable to establish barriers to entry, meaning other players were able to enter the market easily. Driven by a hyped-up frenzy of investor interest around bike sharing, many firms did exactly that.
That these issues might undermine their initial business model now seems rather obvious. Indeed, as one Chinese bike share founder revealingly told Reuters late last year:
It now appears bike sharing is the stupidest business, but the smartest brains of China all tried to get in.
The lesson then is to take valuations with a large fist-full of salt.
In the meantime if you find yourself dazzled by the megabucks valuations for a start-up that has yet to turn a single cent in profit, it might be wise to remember one important thing about unicorns.
They are mythical creatures.
Professor Sumit Agarwal is Head of the Department of Finance and Low Tuck Kwong Distinguished Professor at the National University of Singapore (NUS) Business School. The opinions expressed are those of the writer and do not represent the views and opinions of NUS.