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Unicorns: Capital vs Innovation

Credit Suisse Securities Research, Asia Pacific


In early February 2022, the world had 1000 unicorns, with a combined market value of USD3.3 trillion, nearly 3% of the market capitalization of global stock markets. A decade ago, an unlisted firm with a market value above USD1 billion was a rarity, hence the name ‘unicorn’. We see three key reasons for the exponential growth of the unicorn club.


The first and most important factor is the surge in venture capital (VC) and growth investing. Among various forms of capital, debt has been around for thousands of years, and equity capital for at least a few hundred years (joint-stock companies already existed in the 15th century), but formal VC is just decades old. In its early days in the 1960s, the industry managed a few hundred million dollars in assets, nearly all of it in the US, making small investments in early-stage companies. Since then, the VC industry has expanded in size and across geographies. In 2010, it made investments worth around USD50 billion, and in 2021, the amount invested was 12 times larger – nearly USD600 billion. This has allowed firms to stay private longer.


Changing demographics, as well as growing inequality of wealth and income have contributed to a global surge in private equity (PE) investments in the last two decades. As these trends (among others like growing global trade) push down inflation and interest rates, large institutional asset managers like pension, insurance and sovereign wealth funds have been pushed to take more risks, creating large pools of capital that are chasing growth, even at higher risk. For VC funds, very few investments drive the bulk of returns – often, 5% of investments drive 60% to 80% of returns. This is inherently risky, and is unlikely to be the core method of savings for most households. On the other hand, large pools like institutional funds and family offices can allocate some percentage of their capital to VC/PE strategies.


The second factor is that as much as the supply of savings increases, there is also growing demand. Investments in building intangible assets are increasing, as value-add shifts to software, brands and supply-chain complexity from just ownership of physical assets. Intangible investments began to exceed tangible investments in the US more than 15 years ago. These investments are high-risk-high-reward – when they work, they can scale almost infinitely (like a piece of software), and benefit from large-network effects (like social media platforms or ride-sharing platforms), but when they fail, there is no salvage value. Traditional sources of capital like banks would be unwilling to fund them, while the leader out on top industry structure they engender fits the expected return profile of VC/PE funds.


The third factor is that new technology firms are also growing larger at a much faster rate than they used to, and the rapid growth in market capitalization of new firms is not just due to a surge in capital chasing of a few investments. In the listed space as well, the leadership in market capitalization had shifted from energy and financial firms two decades back to technology firms. Not only is the latter seeing unprecedented levels of profitability and market capitalization, but they are also achieving these much faster.


Across the world, the combination of cheaper computing with surging internet penetration (even to rural areas, which are still large in Asia) is enabling new business models and removing inefficiencies from value chains. Going forward, several promising innovations like rapid gains in energy storage transforming mobility and artificial intelligence (AI) applications that can bring down costs substantially and thus improve penetration of hitherto expensive goods and services, the internet of things (IoT) and new standards like 5G, are likely to continue to provide entrepreneurs with opportunities to disrupt existing businesses and build new ones.


It is natural to find periods of excess, as different factors drive the demand and supply of VC/PE capital. For starters, the pace of innovation is unlikely to stay uniform. More importantly, attractive returns in the space have brought in non-traditional funds like public-market investors and hedge funds, and capital has flowed in faster than the absorptive capacity. This may be reversing as interest rates rise, and the market capitalization of several technology stocks corrects. Activity may slow down in the coming year or two.



However, the establishment of this pipeline, which routes risk capital from the rich toward new technologies and new business models, is an integral part of boosting total factor productivity globally over the coming decades, particularly as population growth slows. The VC industry in the US was integral to the development of the West Coast as an innovation hub; the spread of this industry to Asia has already catalyzed much creative destruction and can continue doing so going forward.


This channel has other benefits too. Economies globally (including in the developed world) have struggled to supply growth capital to smaller firms, particularly as banks’ business models are not attuned to smaller loan ticket-sizes, and these firms own few, if any, assets. Such businesses may also be better off with equity rather than debt capital. VC/PE funds, steeped in the philosophy of high-risk investments, are likely to be much better equipped to provide capital to smaller businesses.


While much of VC/PE capital flowing to Asia was foreign in the early years, local pools of capital are also emerging, not only created by the success of the early entrepreneurs themselves, but also with the help of some regulatory support, as governments realize the economic value of such capital.


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