May 8, 2016

Unicorns that belong in the land of make-believe

The best business drama I’ve seen on TV in living memory was Follow the Money, shown on BBC4 recently.

 It was set in Denmark and revolved around an alternative energy company, but it could have been set in London — with a plot based on technology “unicorns” and their promoters. It was educational watching for anyone backing such speculative stuff.

Of course, the series was fiction, but investors who back companies espousing complex, novel technologies need to remember that stories that seem too good to be true usually are.

Britain’s universe of unicorns suffered a severe setback earlier this year when a business called Powa Technologies collapsed into insolvency. This was the creation of a man called Dan Wagner, who acquired a racy reputation in the dotcom era when he ran a quoted business named MAID, which fell to earth.

Powa, his latest venture, went bust in February, having raised £144m in equity and debt since 2013. Almost all the cash seems to have come from esteemed Boston fund manager Wellington Management. Deloitte, Powa’s administrator, says there is no prospect of a return to shareholders or unsecured creditors.

A brilliant young journalist called Oscar Williams-Grut, writing on Business Insider, has tracked Powa’s rise and demise. At its peak it was apparently worth $2.7bn (£1.8bn). Yet in 2014 it had revenues of just £1m, and lost almost £39m.

On YouTube, under the account Powa Leaks, you can watch an eerie staff video of Wagner, filmed a couple of months before his business went bankrupt. It makes fascinating viewing. Wagner chants a Mandarin phrase but says it’s Cantonese. He tells employees there will be no Christmas party or bonuses, but says: “We’re going to succeed . . . I see us moving into 2016 in a very strong and positive way.” His delivery appears manic, while his eyes constantly shift away from staring at the camera.

The former finance chief of the business has stated that Wagner “parked his Bentley in the disabled spot . . . says it all”.

I cannot begin to understand how the business raised so much capital, or why anyone thought it was ever worth anything close to $2.7bn. Nobody has suggested that those who ran Powa broke the law, but I do wonder if its investors did any real due diligence or proper referencing before writing so many big cheques. I hope Wellington’s heavy losses will not put US investors off British tech.

Meanwhile, Silicon Valley has its own problem companies. Due to the boom in unicorns (private start-ups worth more than $1bn) investors and entrepreneurs have been getting ever more ambitious; last year Fortune magazine claimed there were more than 225 of them.

One was a clinical testing business, Theranos, apparently worth $9bn. It is led by chairwoman, chief executive and controlling shareholder Elizabeth Holmes, who invented a new way to test blood. In recent months The Wall Street Journal has carried out a first-class investigation, and the results have been devastating. Officials are now investigating whether it misled investors.

Commercial scientists and doctors I know were suspicious of the business because its technology was not peer reviewed. Meanwhile, the board was composed of the good and the great, rather than scientists with relevant expertise.

These types of venture are floating on a tide created by winners such as Uber. Overall, venture capitalists are raising cash from institutions at the highest rate in 15 years. In theory, this should be good for innovation and job creation. But I hope investors scrutinise the business plans with rigour. Bill Gurley, a partner at venture capitalist Benchmark, has written a brilliant post on his blog about the dangers of over-exuberant unicorn financing. As he puts it, you can hear the sound of a bubble bursting. He writes: “The pressures of lofty paper valuations, massive burn rates [and the subsequent need for more cash] and unprecedented low levels of floats and takeovers have created a complex and unique circumstance that many unicorn CEOs and investors are ill-prepared to navigate.”

I meet young founders of hi-tech companies who seem more familiar with financing than the actual operations of their business. They understand all the venture capitalist phrases. But raising money is not the skill that builds great businesses. Huge successes such as Facebook are incredibly rare.

I suspect many unicorns will disappoint lots of their backers, and venture capitalists who jump on the bandwagon will get burnt. Picking champions isn’t as easy as it looks.