Unicorns, privately backed companies valued at more than $1 billion, are growing in number -- raising fears of a new tech bubble. Reuters

The proliferation of unicorns, venture-backed companies valued at over $1 billion, is raising concerns about a private equity bubble. Uber, the poster child for the one-horned wonders, is now valued at more than $50 billion but saw 2014 revenue of just $415 million, according to reports. Airbnb is supposedly worth $25.5 billion but faces significant legal headwinds. Software company Palantir, with a $20 billion valuation, is up against established, deep-pocketed tech titans. If this bubble bursts, it’s not just wealthy venture capitalists who will get burned -- tens of thousands of jobs could be lost, pensions could take a hit, innovation may lag and the damage could spread to the public markets.

There are now over 80 VC companies worth more than $1 billion, double the number from last year, Forbes reported. 24 new unicorns joined the club in the second quarter of 2015, 12 of which were from the U.S., compared to nine in the same period a year ago. $88.3 billion was invested in venture-backed companies in 2014, compared to $49 billion the previous year. In other words, the bubble is building. "Entrepreneurship has become a fad today and there are too many entrepreneurs, creating the first and necessary condition for a bubble," said Rohit Sharma, founder of Perchingtree Solutions, a Calgary-based consulting firm.

In years past, many of these unicorns would have already gone public. But macro conditions – including several rounds of yield-killing quantitative easing – means there’s no shortage of private capital looking for big returns in private ventures. So many of these companies can indefinitely delay initial public offerings to shield their operations from public scrutiny and oversight by the Securities and Exchange Commission.

What happens if there’s a downturn? Thousands of workers would lose their jobs, for starters. Palantir employs 1,500 people, while Airbnb employs 130 directly and also helps hundreds of thousands of homeowners make extra money. Uber, meanwhile, provides work for more than 14,000 drivers in New York City alone and is even helping to drive auto sales. Add in workers from dozens of other unicorns and the impact becomes widespread and painful.

Widespread Risk

So what’s the risk? Palantir is one of the most secretive companies in the club. The data analysis specialist works with governments and private firms to deliver insights, for example cyberfraud detection at JPMorgan Chase. But it’s reportedly not profitable. With no profits, Palantir must compete with the likes of IBM, Oracle and SAP, which pull in billions of dollars annually. “I think the challenge is ensuring that the insights they deliver have to be really good,” said Anand Sandwal, CEO and co-founder of venture capital database CB Insights. “The challenge is, does it live up to the hype?”

In June, Airbnb was valued at over $25 billion. Anonymous sources speaking to the Wall Street Journal said the company projects $900 million in revenue this year, with an operating loss of $150 million. Douglas Quinby, vice president of research at travel analyst Phocuswright, said the leaked growth objective of profitability by 2020 is “lofty,” with the company needing to greatly increase global market share, particularly in China, to succeed. “I’m not necessarily negative on them,” Quinby said. “The founding team at Airbnb has defied a lot of expectations so far – I’d be reluctant to bet against them.” But the company faces significant headwinds, including the fact that many of its users in hubs like New York City are using the service to rent out their apartments in violation of local laws.

Uber, now a household name, has questionable finances. Leaked figures from Gawker reveal the company brought in $102 million in revenue in the first half of 2014. But it posted a net loss over the two quarters of $161 million. Uber has risen dramatically by providing convenient taxi service at the touch of a button. But how airtight is its business model? This month, local rival Gett launched a campaign offering rides anywhere in Manhattan for $10. Lyft and others are also chasing the ride-hailing market. Officials in numerous municipalities across the world, meanwhile, have charged the company with operating a de facto taxicab company without the proper licenses and insurances. It also faces lawsuits by drivers who say they should be classified as full-time employees – with benefits.

William Hsu, a partner at Mucker Capital, compared the enterprise value of Uber divided by the last twelve months of revenue and found that Uber’s valuation multiple in 2014 was triple that of eBay at the height of the dot-com bubble in 2000.

Uber protest
French riot police secure the Porte Maillot during a demonstration by French taxi drivers, who are on strike, to block the traffic on the Paris ring road during a national protest against car-sharing service Uber, in Paris, France, June 25, 2015. Reuters

Paul Kedrosky, a partner at SK Ventures, said many unicorns are overvalued and have entered bubble territory. This is creating a situation where mispricing is prevalent, and the only way out is either going to be some failed IPOs or a lot of dead unicorns.

Business Crash

If even some of these companies falter, thousands of workers would be out of a job. But the impact would go well beyond that. According to the New York Times, Fidelity Investments is one of the major investors in Airbnb, Uber and Pinterest, investing a combined $390 million. Deals like these, also struck by money managers like T. Rowe Price and BlackRock, pool the shares into mutual funds that go into retirement accounts. Managers argue, however, that mutual funds depend little on individual stock, with Fidelity’s Uber stock accounting for less than 1 percent of total holdings.

Innovation could also suffer if burned investors look to park their money into more proven industries in the future. "Within the entrepreneurship ecosystem, innovation has become a fad where open-ended thinking combined with visual brainstorming is wrongly associated with being innovative," said Sharma. "When the bubble does burst, a frenzy-driven innovation pursuit will also be blamed for causing the collapse and erosion of wealth."

"I think a main effect of a lot of unicorn failures is that investment will likely slow and private tech companies will find it harder to raise money," added Barry Kramer, partner at Fenwick & West. In other words, it won’t be pretty.