Learning from the mistakes of the West’s ‘unicorn factory’

This story was republished with permission from The Realistic Optimist, a paid newsletter covering the global startup scene. It was moderately edited to reflect Tech in Asia’s editorial guidelines.

Sam Lessin recently pontificated on the end of what he called the “unicorn factory system.” The American venture capitalist described a configuration in which each investor along the fictional assembly line packaged companies to raise their next round, forgoing any deep questioning of the companies’ business fundamentals.

This system, Lessin argues, has led to disappointing IPOs such as Bird, whose underlying unit economics did not stand up to the test of public scrutiny.

Image credit: Timmy Loen

Adding insult to injury, Lessin posits that the good companies to come out of that era, such as Stripe, were kept private while the not-so-good companies were dumped on public markets via shady blank-check or SPAC listings. In the US, stringent antitrust regulation has also reduced big tech’s propensity to acquire startups.

The increasingly disenchanting exit path for startups on the factory line has created a snowball effect, where the entire sector’s attractiveness to limited partners, employees, and would-be founders has decreased. The end of Covid-induced zero-interest-rate policies has also turned off the seemingly endless tap of funding the sector used to enjoy.

The result is an existential crisis for US venture capital, which Lessin predicts will usher in the return of more artisanal, less “predictable” VCs and companies.

The emerging market difference

This doesn’t seem to have afflicted emerging market startup ecosystems as severely, for various reasons.

VC industries in many emerging markets are still nascent. There is, in large part, a lack of local VCs capable of leading post-series B fundraises.

Despite American VCs’ 2021 foreign forays, most emerging market ecosystems still face a concrete undersupply of risk capital. This has hindered the development of any such “factory” system – for the better.

According to a 2023 report by Magnitt, there were a record number of deals and exits in the “MEAPT” (Middle East, Africa, Pakistan, and Turkey) region last year. This is more of a personal observation than a scientific demonstration, but I suspect emerging markets’ comparatively lenient antitrust laws are more conducive to a vibrant M&A market.

Most successful startups in emerging markets solve “real” problems. Capital constraints force local founders to find – not invent – a real need, and start thinking about profitability earlier than their Western counterparts. The convergence between increasing digitalization and a growing, more demanding middle class gives founders in these places opportunities to explore.

This last point is vindicated by Nubank. The Brazilian fintech firm disrupted Latin America’s banking sector, riding the wave of the middle class’s desire for more advanced, digital financial products.

Since going public in 2021, Nubank has delivered solid growth. Its future potential stands at the nexus of Latin America’s large potential user base and the plethora of financial services it plans to roll out. The firm expanded regionally but seemingly did so with healthy unit economics.

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