I Want a Horse, Not a Unicorn

This is going to make me sound grumpy and old. Like something out of an Arthur Hailey novel, muttering about the way commerce used to be. But, really, this is about (re)applying logic to how we structure, launch, fund, and run early-stage enterprises. Besides, I'm not old.

I've been thinking about different types of businesses and what about them is (and isn't) appealing. The best-run businesses tend to create good and long-lasting jobs, while offering training and mentoring to the next generation of talent. And they do it while generating a profit, year after year. Meanwhile, the burgeoning "myth of the quick public exit" is exciting to dream about but, in reality, rare to the point of mysticism. As rare as a magical equine animal, sporting a solitary horn atop its head.

That's right. I'm talking about unicorns. In modern business parlance, a unicorn is a fast-growing startup with a valuation of more than $1 billion. [1] Over just the past two years, the unicorn population has exploded, more than tripling in size. It's a stampede of startups, charging their way toward Wall St (presumably down a yellow brick road), towards vast troves of riches for their lucky investors. The allure is real. And really, if you've got a billion-dollar idea, go for it. Fortune favors the bold. But in this case, the data do not.

Over the past years, as the number of unicorns has increased, so have the number of investor write-downs. Major investment institutions have been forced to re-assess what the state of affairs in the Magic(al) Kingdom of startup valuation has been. And, probably, for good reason. Somewhere along the line, forgetting lessons learned when the first tech bubble burst, we returned to a state of wild-eyed optimism, captured most accurately by phrases like, "don't worry about profitability," and "our users don't pay for the service now, but we have a plan to convert them in a year (or two, or three)." It's a thought process that can produce huge (paper) wins [2] but those wins are, statistically, very rare. [3] After all, they're not called unicorns because they're common.

So, I want a horse. Not a unicorn. And for business purposes, we should define a horse as "a company designed to acquire paying customers, reach profitability, generate distributable cash-flow, stable employment, and long-term returns for investors, without being forced into a public offering or acquisition." In other words, a horse is real and tangible and, when it grows up, it can run for a very long time. As opposed to a unicorn. Which is basically a figment of the imagination.

I'm certainly not alone in this feeling. Community banks, long the financial foundations of towns across America, have understood the concept of cash-flow and asset-backed lending for years. Corporate bonds, among the more predictable of asset classes, are based upon the notion of a long-term ability to generate cash to pay a yield. Manufacturing, a sector literally built on making things, has always required a paying customer at the end of the value chain. And one of the most prominent investors of our time (or, perhaps, any time) has long understood this too.

In 1967, a relatively young man used proceeds from his interest in a textile business to buy control of an insurance company called National Indemnity. National Indemnity generated a lot of cash. You might even think of it as a horse. Over the years, using the cash from National Indemnity (among others) [4], he bought many more companies, and those companies all had paying customers at the other end. In essence, he bought himself a herd of horses. And now, every spring, a herd of humans run through the streets of Omaha in order to hear him speak. Because that young man was Warren Buffett, his company is Berkshire Hathaway and, if it's good enough for him, it's probably good enough for us as well.

[3] The Center for Venture Research reports that a total of 73,400 entrepreneurial ventures received angel funding in 2014, in the US. That's 229 (the number of unicorns globally)/73,400 (just the US deals)= a 0.0031 chance of becoming a unicorn. Optimistically.

[4] "Indeed, had we not made this acquisition [National Indemnity Company], Berkshire would be lucky to be worth half of what it is today [2004]." https://www.nationalindemnity.com/About_History.aspx