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Comment by marcamillion | Hacker News Reader

I think the mere fact that they just raised $50M @ $500M valuation is the reason that this price is so high.

Those investors in that round had to at least double their money...if the price was indeed $1B, that's all they did. Just 2X. Although, the argument can be made that a 2X return in 1 - 2 months isn't bad...but then again, VC funds don't have a 2 month life, so over the long-term value (i.e. 10 years most-times) of that fund I am not sure how beneficial that is.

Although, I guess they can't be too pissed because it must feel good to be able to at least return something to their LPs in such a short time frame.

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And people say we're not in another bubble.

People through comments saying things like "well, VCs needed to double their investment - this lets them do it in a few months"

Wish I lived in a world where I should have expectations of a several hundred percent ROI on investments.

You are just seeing the good cases here. A 10X return on any one investment pays for all the bad investments. If I remember correctly, the return that Sequoia got on their YouTube investment paid for the entire portfolio many times over.

But more importantly than that, I think it was one of a very few that were good in that fund. I believe that particular fund was particularly bad because it contained remnants of the dot com bust - so only 1 - 3 of their investments in that fund were profitable, and only 1 was enough to pay for the entire fund.

I am not remembering EXACTLY so my numbers may be a bit off...but you can just imagine how annoying it must have been to be a partner in a fund and be telling your LPs that you have essentially lost all their money - and thinking about this for the entire 10 year life of that fund.

Just for at the last minute, almost literally, all of that changes.

People don't think about it, but it's not easy to be a VC.

yeah, but they paid $1 BILLION dollar for a company with NO business model.

This buy was just another way for connected Silicon players to cash out on the facebook IPO, since the IPO window for web 2.0 is closed.

Google bought YouTube for $1.65B when YouTube didn't have business model. It was critiqued a lot because of this, but it established Google as a dominant player in video space and it's ripest fruits might be seen in coming years when media consumption moves more and more to mobile.

I grant that $1B sounds a lot for Instagram and it is harder to see similar commercial value in photos than in videos.

My personal take is that in addition to friend connections, already posted photos could be the strongest lock-in for users that Facebook has against future competitors.

YouTube has a business model now, but is it a profitable business unit? (I'm not trolling; this is a serious question about business models.)

Trust me, Youtube is very profitable. Major multi-national brands have to pay $100,000's in Google Adword purchases to have their own branded channel. And if you want to change the look of your channel? Pony up another $100K.

It is very profitable now, however it wasn't when the purchase was made -- therefore it was a wise decision.

YouTube just recently turned profitable in the last two years. It was hugely unprofitable with an unproven business model at the scale at which it was bought.

yeah, and Yahoo bought Flickr for hundreds of millions. And Flickr never became a profit center for yahoo. Now, Yahoo is laying off thousands of workers, and is close to dead poool, because of all its malinvestment in web1.5 (flicker, geocities, delicious, etc).

Video has a higher value proposition than photos. Look @ how hard flickr has struggled turning photos into a sustainable business model.

I'm comparing apples to apples. You're comparing apples to oranges.

Flickr was in the tens of millions, on the order of $30 million. That was the blog buzz around the price, anyway.

Gonze! How are you my man?!

You could have said the same about Yahoo acquiring Facebook itself for $1 billion, if that deal had happened. It's clear now who would have got the better deal there.

Certainly that doesn't mean every large acquisition is justified (e.g. Bebo) but it also means you can't just automatically apply the "company X has no clear business model today and so shouldn't have been bought for Y" argument to every such acquisition either.

I am actually wondering if the value was too low. They are crossing the chasm so to speak and moving toward mainstream very quickly. I don't know where they would have ended up, but if they could have negotiated an upround with the founders and VCs taking some cash off the table it may have been a better move.

I fully understand that if I had a $1B offer for a company that I would literally be sick turning them down, but the potential was there for something really big. If I could keep going with $10m in the bank, I would like to think I would try.

I'm not convinced Yahoo buying Facebook for $1 billion would have been a good deal for Yahoo. Yahoo never would have been able to make Facebook nearly as successful as it is today. I have my doubts Facebook would be worth even a $1 billion today. Yahoo has an awful track record of making the worst out of their acquisitions and I don't see how this would have been any different.

They have a business model: filters that cost money.

You need some serious perspective, they just got 2x return in a few months. They can, I don't know, re-invest the money perhaps?

And you're cherry picking out one of many Sequoia funds (and still a successful one at that) to point at to call VC life hard? A dot-com period fund as well?

How many other hit funds have they had?

Sequoia estimates that 19% of the NASDAQ’s value is made up of firms they have funded.

There was an article on HN about how most funds are structured so you can't, you know, re-invest the money from an exit.

It doesn't work that way -- no, they can't reinvest the funds.

In many (pretty much all) funds, you can't re-invest capital earned from the fund.

I recommend checking out the book 'Venture Deals' by Brad Feld and Jason Mendelson. They explain the various structures of funds, why they're structured that way, and how it influences the decisions the investors make.

I would like someone to sit me down, and explain the economics of why accept a buyout immediately after raising. And NOT the part of accepting $1 Billon. But why they closed a round with a buyout just around the corner.

For 2 main reasons that I can think of:

a) You don't know if the acquisition will actually happen. Therefore if it doesn't, you aren't left with nothing.

b) It gives you a stronger bargaining chip to increase the price of the acquisition because you literally have a strong alternative. Instagram could tell FB to screw off, they are already getting $50M.

I wonder if the investors (Sequoia, Greylock) knew of the pending acquisition offer from FaceBook when they put forth the 50M investment? If they did, that was the easiest investment ever.

If they did, was it legal?

Yes.

It might actually be illegal not to disclose that.

They may have brokered the deal, and at least gave credibility to the investment to make it easier for Facebook to pay the price. Beautiful result for the portfolio - we are in a bubble and flipping this so quickly means that they have $ return in the bank way before the more speculative investments.

I believe I read that Marc Andreessen is an investor (and board member?) in both companies. Seems painfully unlikely they did not know. And why wouldn't Instagram TELL them?

Raising a round SETS the pre-money and post-money valuations of a company. I've known companies that have taken a measly $8M round when they are already independently profitable.

It's basically a bargaining chip. Let's look at two different scenarios:

1. Your last round of financing was two years ago and you raised $2M at a post-money valuation of $8M. Two years pass and you're hot, what is you company worth? Look at some comparables (which the acquirer will try and rip apart). Do a multiple of your revenue (which the acquirer will try and rip apart).

2. Now you're hot and you think you might be acquired (or maybe not!), you raise $5M at a $50M post-money valuation. Now when you sit down at the bargaining table, you can say "Well that VC over there thinks we're worth $50M, what do you think we're worth?"

In option 2, you've got a lot more bargaining power.

100% return in 3 months (it won't close to the end of the quarter) is an annualized 400% return. If you're a VC you took $50M out of a fund put back $100M, now you can make 2 bets at $50M when before you only had one. I don't see any way that this isn't a great deal for the VCs.

That being said, this wasn't part of the S-1 and Facebook really has to tell potential investors how this will affect the financials, so presumably there is a revised prospectus or perhaps S-1 in the works.

When VCs make money they generally don't reinvest it, which is why they always look for 10x in the long term rather than 2x in the (very) short term.

Well...if I am not mistaken, the way VC investing works is once an investment return is made - they have to distribute it back to the LPs immediately. They can't just "re-invest it" into other companies.

Unless those economics have changed, but I don't think they have.

It is in that light why I say, it seems a bit precarious. Essentially what would have happened is, these VCs would have contacted their limited partners and said, we have an investment we want to make - send us the money now (this is after the limited partners already committed to giving them that money). The LPs then wire the VC fund the money. The VCs then wire that money to Instagram.

3 months later, Instagram wires the money (assuming it was all cash, which we know it wasn't) back to those investors, which then have to wire the money back to their LPs. So technically, it doesn't REALLY help their portfolio as much as if they got a 10X return in a few years because the money was put to work for a shorter period of time.

Although, if you are 'annualizing' the return properly and assuming a 33% return each month, then the yearly return is actually 29X (compounded), but we digress.

Usually, that's not how it works (VC's don't reinvest) but I will have to admit I'm fascinated by the story behind a large round so quickly followed by an acquisition. Too bad we'll likely not hear it.

Like everyone else already said, VCs can't reinvest so they dont really want 2x returns.

Anyways, there's a excellent blog post that explains this very clearly. It is written for founders to understand the VC's perspective when investing. Does anyone know what I"m talking about?

http://www.danshapiro.com/blog/2010/08/vc-insanity-economics...

Thank you thank you thank you!

I been looking for this article for the last few months now.

Wow that is an awesome article, so one wonders if a fund is nearing its 10 year expiration, can they spend the 'reserve' on a fast exit like this?

Great article! Also related: Brad Feld's book "Venture Deals" goes into detail on a lot of what Dan Shapiro mentions in this article.

At the standard 2 and 20 it's a really great deal. Assuming this was a one time sort of fund from the LPs as other posters have suggested. The VCs are looking at putting $12 million in their bank accounts in 2 months.

I haven't been able to find anything anywhere that says they actually closed that round - merely that they were looking to raise money at that valuation.

EDIT: Open mouth, insert foot: http://techcrunch.com/2012/04/09/right-before-acquisition-in...

Techcrunch just confirmed it - http://techcrunch.com/2012/04/09/right-before-acquisition-in...

Are you joking? You don't think a 100% gain is good for a 1-2 month timeframe? The most successful hedge funds in the world have money thrown at them if they can average 50% gains over the course of a year. And that is an outstanding year!

I realize the economics of hedge funds and VC funds are different in that VC's take a shotgun approach and hope that one out of ten investments makes up for all the losers, but on any single investment a 2x return is outstanding. On the surface it looks like the founders got screwed nicely on this one.

> if they can average 50% gains over the course of a year

That's the point, this isn't what happened. Given the choice between 2x return in 2 months or 10x return in 120 months, there's no contest at all. That initial investment that returned 2x is now out of play for the life of the fund. If the fund's life is 10 years, the return is 1.1x, not 2x.

Except that because they'll get paid x% in FB stock, the life of this investment is now extended until they choose to sell the FB stock, which means the return could go up (or down!).

Okay, you go ahead and bet on the companies that will pay you a 10x return in ten years and I'll take the 2x return in two months. Will Instagram even exist in 10 years? Who knows? I wouldn't bet on it.

BTW, you're absolutely right. The 2x return extrapolates to a return of trillions of dollars over ten years, so there really is no contest at all.

It doesn't matter if you run a hedge fund, a VC fund, or a trust fund. A 2x return is a 2x return, and anybody would take it any day. Anybody who wouldn't has no business working in finance. Just because you assign a ten-year time frame to your portfolio does not diminish the return on that investment, so the return on your $50mm is 2x, not 1.1x.

If you guide your investment strategy based only upon what you hope will happen in the best-case scenario and look down upon investments that double your investment, you're making a mistake. The only reason they need a 10x return on their winners is because at least nine other bets are going to lose. Any win adds value to the fund. As a fund manager would you rather the $50 million have been plowed into a business that returned 0% which is what you expect to have happen ~90% of the time? Do you understand why criticizing this investment makes no sense? You're comparing a great investment to the few investments that turn out to be astronomically fantastic instead of the vast majority that lose money.

> It doesn't matter if you run a hedge fund, a VC fund, or a trust fund. A 2x return is a 2x return, and anybody would take it any day. Anybody who wouldn't has no business working in finance. Just because you assign a ten-year time frame to your portfolio does not diminish the return on that investment, so the return on your $50mm is 2x, not 1.1x.

This is your key misunderstanding. When the fund starts, you lock up the money for a specific amount of time (say, 10 years), and once the money's been in, it can't go in a second time. So if you're near the beginning or middle of the fund, and the fund was < $500MM or so you probably wouldn't take 2x on $50MM today, because that $50M will be out of play for the next (say) 9 years.

In other words, it does diminish the return on that investment, because that $50MM is now out of play. Every dollar gets one shot of multiplying, and when it's done it's done, as far as the fund is concerned.

If the fund is near the end of its life and for some odd reason they still have $50MM sitting in it, then yeah, it'd be a great move.

I fully understand that. What I am explaining to you is that the idea of a VC fund is to create a return by investing money in a portfolio of companies which overall, should create a positive return. There is absolutely no way of knowing going in what the fund will return. If I figure that out of ten investments one will create a positive return great enough to pay for nine others, that does not mean that I am hoping or expecting that each of the ten will return me 10x. Keep in mind that those nine losers are completely independent of each other. If five win and five lose, all the better. If five win and three break even and two lose, that's even better.

If I invest $100 into 10 different stocks, and I figure that nine of the ten are going to be losses, then I hope that one of the ten will return me at least $1000, or 10x my original investment. That's very different than saying that any of the ten that returns me less than 10x is a disappointment. On the contrary, if one happens to return me 10x over the lifetime of my portfolio and another returns me 2x, then I am even better off than I anticipated.

Also, if every dollar has one chance to multiply and you take one tenth of the fund and immediately double it at the beginning of its lifetime, that is an outstanding outcome. Just because you can't reinvest the money in that fund does not mean it is lost, it is simply paid out to investors right away.

Anybody who has taken a finance course knows the simple principle that a dollar today is worth more than a dollar tomorrow. It is NEVER better to make a return of equal percentage later in a fund than early. Instead of having $50 million to invest in the original fund in the same companies as before, you now have $100 million to invest in the same companies as before. The fallacy in your logic is that you are hung up on the required return for that single fund.

The only way what you are saying is valid is if by investing that $50 million in Instagram, they missed out on the opportunity to invest in another company that at some point in the future would have returned more. In a window of about two months, I highly doubt that's the case. Again, once you have doubled your money and gotten it back, you can invest it anywhere you like, including the same companies you may have before. But now you have twice as much money. There is nothing magical about that fund that makes its investments more special than another.

> Again, once you have doubled your money and gotten it back, you can invest it anywhere you like, including the same companies you may have before. But now you have twice as much money.

Again, that's exactly wrong. As far as the fund is concerned, that money's gone.

Let me help you understand with this link: http://www.danshapiro.com/blog/2010/08/vc-insanity-economics...

Pay special attention to the section entitled, "They don’t appear to be particularly interested in making large amounts of money."

Exactly. The money is gone "as far as the fund is concerned." But that money is no more gone than it is when I sell stock and convert it to cash. A fund not recognizing money does not mean that that money ceases to exist.

Don't you think that maybe Facebook acquired Instagram because of the latest round?

Angel / Series A investors are shooting for 10X. VCs hope that investments in more mature companies with users, revenue, etc. get 2-3X. I don't think any of the VCs that invested last week are bummed on 2X in 5 days.

Wait a sec - if the investors put in $50M and the sale price was $1B, isn't that a 20x return in 2 months? Or am I doing the math wrong?

For $50M the investors didn't buy 100% of the company. They bought something around 10% (assuming the valuation was $500M)

The acquisition was in stock and cash. So the VCs that put up the $50M may have just gotten $100M in pre-IPO Facebook stock, which may well dramatically increase their return post IPO.

Ahhh....good point. That does change the formula a bit, but even still...what's the likely 1 year return on pre-IPO FB stock? 3X if so much? I doubt it.

Anyway, it's better than 2X, so I guess they can't be pissed.

But, quite possibly, it could be .5X, or .25X... Current FB valuation is somewhere around 25X revenue ...

Honestly, in the tech industry, a 25 P/E ratio is yawned at.

P/E is around 100.

This has to be mostly stock...how much cash does FB even have? Enough to casually hand out hundreds of millions?

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