Growing Numbers of Start-Ups Are Worth a Billion Dollars | Hacker News Reader

Growing Numbers of Start-Ups Are Worth a Billion Dollars

nytimes.com

72 pointsjayzee49 comments

I've struggled to say this and not sound snarky, but, in the face of this, how can we not admit that there's a bubble? Do we really think that all 40 of those startups could actually find someone to buy them out, completely, at 1+ billion each? (And I don't mean with the plan to turn it into an IPO and get rich/get out quick)

A billion dollars for a survey website with no clear sustainable competitive advantage?

Spotify seeing a ~3.5 billion valuation in the face of an estimated loss of 40 million for 2012 – owing your existence to an industry that is kicking and screaming into the digital age (and with strong bargaining power and a strong sense of greed)? It's possible – and Spotify is an exciting entry with some clear success, but almost 4 billion in valuation strikes me as bubble territory, at the moment, given all of that...

Just my daily dose of skepticism...

Do we really think that all 40 of those startups could actually find someone to buy them out, completely, at 1+ billion each?

That's not the bet investors are making. They're betting more on IPOs than acquisitions, and they're betting that the entire portfolio will end up net ahead, not that each individual company will. And indeed it would be extremely unlikely for a group of 40 startups not to end up with a power law distribution of exit valuations.

But the statement "40 companies worth 1 bn+ each" implies that the clever people think each company is a really sellable at 1 bn

Otherwise should we change the definition of "valuation" ?

Edit: it is difficult not to sound snarky on this subject. If a respected investor's first reaction is to see beyond the individual companies and into the whole (and I agree tech startups will produce billions of value in The next five years) that's good - but it reflects a jargon problem perhaps - if the sophisticated investor sees a group of billion dollar valuations and thinks I will invest in them all and come out ahead it is a different thought process to the layman - that a valuation of a billion means it is worth that much.

While we should allow for a degree of sophistication investing in startups, it is still a stretch of jargon to make Humpty Dumpty proud

To say that each of the 40 companies will be worth at least 1 billion is indeed unlikely.

But all that is required for the investors to be "rational" is for the total value of all 40 companies to exceed 40 billion.

So if two companies end up worth 25 billion each and the rest are worthless, that'll still have made it all worthwhile (assuming as an investor you diversified across all 40 companies).

In this scenario, we could rationally say that "each of the 40 companies had a 5% chance (2 out of 40) of being worth 25 billion dollars, which made them worth 25/20 = 1.25 billion dollars each".

But that is not what a common dictionary reading of "40 companies all with a valuation of over 1billion" means.

Yes, that is how a sophisticated investor (who has all 40 companies in their portfolio) will see it.

It is not what a layperson will read - and that is likely to be a problem - jargon should not conflict with natural interpretation, it should complement it.

It doesn't mean that they think someone would buy the company for $1B now. It means that they purchased some stock for a price equivalent to buying all of the stock for $1B, and that they believe that this is a good bet to make given their risk tolerance, the possible outcomes for the company, and the likelihood of those outcomes.

I think that's what I mean - I hear "company valued at 1 bn dollars" and I have to do this mental and linguistic gymnastics leap.

A list of 40 companies valued individually at 1 bn is a bubble, a portfolio of companies only a fraction of which will generate significant returns is a sensible investment spread.

But that is not what the words used mean when I look in a dictionary. Especially as few investors have all of these in their portfolio (if any).

The verbal gymnastics required to differentiate between what VC's seem to mean by valuation and the common-sense use of the term is one of the key things that makes this a bubble.

VC's are okay buying a share of a company as-if the company were worth a billion+ because they (rightly) believe that they can (frequently) turn around and exit in an IPO and get a significant return by convincing others that the company is worth a lot of money – never mind that the long-term financials and competitive advantages aren't there to back that valuation up.

As a (relatively) short-run money making scheme, many of the VC's have it spot-on, but at some point, if the markets can't sustain the aggregate valuations of all of these multi-billion dollar valuations, the IPO values will dry-up and someone's going to be left holding the bag. That is to say, the bubble will burst at some point if it's not carefully deflated.

Same game, different names. Here's Jim Cramer in 2000.

"You want winners? You want me to put my Cramer Berkowitz hedge fund hat on and just discuss what my fund is buying today to try to make money tomorrow and the next day and the next? You want my top 10 stocks for who is going to make it in the New World? You know what? I am going to give them to you. Right here. Right now.

OK. Here goes. Write them down -- no handouts here!: 724 Solutions (SVNX), Ariba (ARBA), Digital Island (ISLD), Exodus (EXDS), InfoSpace.com (INSP), Inktomi (INKT), Mercury Interactive (MERQ), Sonera (SNRA), VeriSign (VRSN) and Veritas Software (VRTS)."

http://www.thestreet.com/story/891820/the-winners-of-the-new...

My goodness. I thought "they can't all have done too badly" – if one did well it'll balance out. I was wrong.

All of them appear to be bust except VeriSign, who are massively down on the peak valuations they had in 2000. It's weird, it looks like a sensible linear growth except someone has scribbled over 2000 and 2001. If you had bought it in the bubble, you have lost a ton of money, even now, even though they've done well since.

Of course it's a bubble. I think most of these will burst, but some of them will withstand it.

One thing to remember: it's in the best of interest of everyone involved in a bubble to deny there's a bubble. These investors who say "it's different this time" have no credibility.

What makes you say there is no clear competitive advantage to SurveyMonkey?

> I've struggled to say this and not sound snarky, but, in the face of this, how can we not admit that there's a bubble?

Is this actually a controversial statement? I don't think so. Startups can be fueled by passion but ultimately are about making money. I sort of assumed most folks here were here to try to cash in on the bubble before it's over.

It's not surprising. Much of the stock market is chasing an all time high.

The Fed has got bubbles roaring all over the place, from corporate debt to treasuries to stocks to a new brewing real estate bubble to student loans (they directly fund / make possible all of it).

Also, a billion dollars is now worth maybe half what it was in 1998 (some would argue a lot less than that, eg when run against gold, silver, oil, and other dollar based commodities).

These start-ups should appraise their businesses as objectively as possible, and consider selling before this latest bubble explodes.

The cheap money piper will be paid sooner than later.

Money supply has rocketed since 2008: http://research.stlouisfed.org/fred2/series/BASE/

You cannot discuss thee money supply without discussing the money velocity.

The money velocity has tanked: http://research.stlouisfed.org/fred2/series/M1V http://research.stlouisfed.org/fred2/series/M2V

Hey, this is off topic, but I am no economist and I am curious. I've heard your argument before, and it seems really obvious that this must be the reason we don't have a lot of inflation.

But what is stopping all the money that has been printed from at one point entering the economy and causing inflation? From the previous chart, I read that the amount of money in the US economy has more than quadrupled. Is this a correct interpretation?

Most of the money is passed between central banks and technically insolvent[1] banks, helping them repair their balance sheet and dispose of toxic assets.

http://dailybail.com/home/chart-of-the-day-feds-balance-shee...

Some of the money seeps into the economy and may be inflating stocks and other assets. For example, banks are given loans at zero interest[2] and they can use that money for whatever, e.g. proprietary trading, bonds/treasuries, etc.

Perhaps some of that money finds its way into investment funds and eventually tech start-ups?

[1] http://www.ritholtz.com/blog/2012/02/fasb-sells-out-unsurpri...

[2] http://www.sanders.senate.gov/newsroom/news/?id=9e2a4ea8-6e7... http://www.bloomberg.com/news/2011-12-23/fed-s-once-secret-d...

Will this money be removed from the economy at some point? How?

Also, there's a billion dollars and then there is a billion dollars. A billion dollars of oil is a valuable commodity. A billion dollars of start-up stock is not necessarily such a great thing unless you can find someone willing to buy all of it, right now.

Of course, sometimes a billion dollars of startup stock is worth much MORE than a billion dollars, whereas a billion dollars of oil is basically worth a billion dollars.

Equity in fast growing companies is high beta, but that doesn't mean it's fake.

> Equity in fast growing companies is high beta, but that doesn't mean it's fake.

It depends. The Equity should be based on future expectations of return. For Amazon and Google, there are now clear business models to drive their value forward (for Amazon it may be rather longer term than for others) but for startups it is less obvious. Most of them have no idea how to generate value and how to grow forward, and their actual "utility" as a service may be questioned.

The trend towards over-valuing the startups currently is also coming from the fact that the housing bubble has exploded and investors and putting their cash in other fields where they expect to earn more/lose less money.

Name the billion dollar companies with no business model. The fact is once a company is successful enough to go public it's often still risky, but it's extremely rare for them to reach that point without a model.

Twitter is valued at 9 billion dollars, and generates 400 millions revenues per year (planned for 2013).

To get an idea of their potential profits :

http://www.businessinsider.com/heres-what-twitters-2012-oper... "Annualized, that operating profit could be as much as $116 million this year. (Assuming the numbers are true, of course.)"

It means that return on investment would be, if they were in a situation where they would return everything to shareholders, of 1.2%. That's very weak for a company valued at multi-billions, and it is not clear how they can generate much more profits in the upcoming years.

That's what I am talking about.

And Twitter is one of the better ones, by the way.

"Pinterest, an online scrapbooking and social networking site with no revenue, became worth $1.5 billion in less than three years."

Does 'no revenue' qualify as a business model?

> Does 'no revenue' qualify as a business model?

Only if "no revenue" actually means "no profits". There are perfectly sane business plans that grow the company and pay all the salaries, but don't turn a profit. It can't go on forever, but it's not a disaster either.

I suspect the OP didn't actually mean "no revenue".

The only way equity can have a positive value is if it generates ROI. No-profit-but-pays-the-salaries is a lifestyle business, which is great and all, but the equity is worthless.

Pinterest's business model, of course, it getting bought by Facebook, and that is indeed a little bubbly. Basically, if Facebook slows down, then the entire cottage industry of fancy social media startups hoping to get bought will collapse.

> The only way equity can have a positive value is if it generates ROI.

Yes, but If the company's value increases, that increases the value of shares, even in the absence of profits. This is one reason a no-profit business can attract loyal investors -- that and the promise of future profits, of course.

> No-profit-but-pays-the-salaries is a lifestyle business, which is great and all, but the equity is worthless.

Not so. A company's equity represents the company's value, not its present profitability (although some equity investors require profits, other are satisfied to see growth). One can grow a business by running at an apparent 0% profit in a way that causes the business size and customer base to grow over time. The argument can be made that business expansions can only result from profits, but this can be structured as essential equipment replacements, personnel increases and so forth, in a way that profits remain at zero.

Yes, of course. I read the GP as meaning never turn a profit beyond salaries, but on a second reading, that's probably not the intended meaning.

Are you implying that no revenue is a valid business model?

> Are you implying that no revenue is a valid business model?

Did you read my post? I said the opposite.

What's missing in this article is the impact of liquidation preference on valuation. The billion dollar valuation that a VC invests at is simply the price they have to pay to get in the deal. For fast-growing startups competition is fierce, so valuations often become dizzyingly large.

The best case scenario is that the startup turns out to be the next Google and everybody gets rich. The worst case (and more common) scenario is that reality hits and the startup sells for $500M instead of $10B. As long as the invested capital is less than $500M, the VC will be getting all of their money back.

The valuations at which VCs invest are not unconstrained though. The valuations at which they invest have to be on average a lower bound on eventual exit valuations, or they'll at best break even, and a VC firm that does no better than break even in one fund will have a hard time raising its next one.

E.g. if a VC fund invested in 10 companies at a valuation of a billion each, and 9 tanked while one ended up being worth 20 billion, they'd fairly happy. But all 10 can't tank. It has to work out on average.

I'm not familiar with all the startups mentioned, but I have to say this: I think Pinterest will be a several billion dollar company and either IPO (likely) or get acquired by Amazon (maybe). If I could buy the stock a decent price, I would.

I say this based on (a) my own experience seeing it drive traffic to some recent consumer projects and (b) seeing how every woman in my life (from my 18-year-old daughter to my 62-year-old mother in-law) uses it as a giant shopping list for their lives.

Something is worth exactly what someone else is willing to pay for it. But does that mean that a purchase of eg 5% of a company at a high valuation makes that company worth 100% of that valuation? Probably not. Makes for interesting reading though.

> But does that mean that a purchase of eg 5% of a company at a high valuation makes that company worth 100% of that valuation? Probably not.

No, it means exactly that. How else do you think valuation is computed?

I might really want to invest in you, so I'll blow the valuation up. I might even be the only person willing to pay that price. But that doesn't mean I want to buy you outright at the valuation.

In practice that doesn't happen. In these late-stage rounds, there is not usually a single investor willing to pay way more than other investors. And even if there were, the company would think twice before selling at that price, because it would just set them up for their next round or IPO to be a down round, which would not be good.

But see, that's kind of the thing--how a valuation is computed and what that actually means are two different things. For instance, let's say I put $10,000 down on a house in 2007 that's worth $500,000. Is that house really worth $500,000, or is that valuation a side effect of easy lending? I guess it depends on when you calculate that worth.

But take 5 companies that have a combined valuation of $5 billion according to their last round. My point is simply this: those companies together are not actually worth 5 billion dollars, in that you cannot find someone to buy them at that price. You can sell portions, sure. But you end up with less than the 5 billion quoted in NYT.

But as pg points out, in practice, nobody is trying to buy companies that way, and there are many other factors at work. And hey, maybe 4 of those companies go out of business but one of them is the new new thing--then it just doesn't matter and you've been successful as an investor in super risky businesses. But even still, there's a difference between the cost of part of something versus the cost of the whole--same difference between paper wealth and actual wealth.

Dave makes a very valid point, which is that the market is often illiquid. Pinterest and AirBnB have $1.5-2.5B valuations right now, but how quickly do you think they could find an acquirer at that price? Quora's last round priced them at $400M, but I bet you'd be hard pressed to find someone who's willing to buy them at that price in the next 3-6 months.

Investors who invest in a company at a valuation of a billion or more don't care about potential acquirers anymore, because an investment at that kind of valuation is a bet that the company will go public.

It stays 100% of the valuation as long as the founders are not looking for a buyer.

What is a billion? A few things worth so much:

American Airlines' annual revenue: $22 billion UCLA endowment position (assets minus liabilities): $1.7 billion 500 MWe coal plant: $0.650 billion Airbus A380: $0.400 billion F-22 Raptor unit cost: $0.150 billion Falcon 9 space rocket: $0.050 billion MRI machine: $0.001 billion

So, pinterest is worth more than a coal plant but a bit less than UCLA's endowment.

A fun list to read: http://en.wikipedia.org/wiki/List_of_megaprojects

The procurement cost of a B-2 bomber was $929m in 1997 dollars (roughly $1.3bn today) so in a way, Pinterest is worth slightly less than a single plane ;-)

“Mobile disrupts personal computers, a market worth billions. Cloud disrupts computer servers and data storage, billions of dollars more. Social may be one of those rare things that is totally new.”

Isn't this logic flawed? It assumes there is a zero-sum game (with the exception of social), but the valuations are assuming that it's not a zero sum game (hence record high PE ratios for cloud computing). There's a difference between stealing market share and creating new ones.

Simple explanation: Investors are desperate for yield.

E.g., Current yields for 10-year Treasuries are about 2%, which in real terms is effectively zero given that inflation is tracking just below 2%.

So any asset that generates steady cash flow (e.g., Apple stock), or is considered to have the potential to generate future cash flow, will be hugely overpriced.

Almost two years back, we had written some points on facebook's secondmarket valuation, which we think is relevant to the discussion here -

http://statspotting.com/2011/03/the-truth-about-facebooks-va...

Your 4 points at the end are all true (and true in general), but Facebook's valuation on SecondMarket was not a stretch-- in the IPO they sold 425M shares at $38.

Evernote, MobileIron, Pure Storage, Marketo, DDS and SurveyMonkey... what do they have in common?

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