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STARTUP

There's No Way Instagram Is Worth $1 Billion
 

The start-up may have pulled down a billion-dollar payday, but that doesn't mean it was worth it.

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So, Facebook buys Instagram for $1 billion. With a B. For a company that has made virtually no money. The founders netted $500 million. Good times are here again, right? Not so fast.

Sure, Instagram has been wickedly popular, and Facebook has the combination of cash and stock to pick up what it needs. It's not as though CEO Mark Zuckerberg, COO Sheryl Sandberg, and all the other members of management have been making one mistake after another. Facebook is well primed for an IPO that could make it immediately worth $100 billion.

Some think the deal was worth it. You could make an argument that it might have been for Facebook in particular. But was Instagram objectively worth a billion? Only when you have your head in the clouds, up where the tech bubbles fly.

Not every company sells to Facebook

Facebook is in unusual circumstances, where perhaps no other technology has ever occupied. It has received literally billions in venture capital. Within a few years, the company has become the dominant force in the important and influential area of social networking. Facebook needs to address a number of factors:

  • The company's value is tied to its growth. Given its current number of customers, additional growth as a percentage of what it has is difficult. So Facebook needs to find new areas of business and acquire companies that can help bring more customers.
  • Part of Facebook's importance is its control of social networking. That means keeping competitors at bay—whether Google, Twitter, Yahoo, Apple, or anyone else—becomes a bet-the-company endeavor. Controlling what is becoming an influential and potentially dominant player in consumer photo sharing, a critical part of social networking, is a must.
  • With all the money that has been put into Facebook, an "ordinary" IPO is unacceptable. There are too many investors who want too big a return.
  • Given the amount of cash the company has and the expected value of the stock, buying Instagram wasn't a struggle.

The problem comes when you realize that there is only one Facebook. No other business faces the unique combination of driving needs and available cash that powered this deal.

Don't judge value by someone else's spending habits

That gets us back to reality. It's like the New York City restaurant Nello that allegedly has been known to charge $275 for a plate of pasta or $15 for water. There are people in the world who could drop such sums without a second thought, but they are relatively few.

Pull Facebook out of the equation for a moment. Is Instagram, on its own, worth even the $500 million valuation that it got with a $50 million investment from VC firms Sequoia Capital, Thrive Capital, Greylock Partners, and Benchmark Partners right before the Facebook purchase?

Instagram may have been popular, with tens of millions of users, but it had zip for income. So, were the VCs smoking something strange before putting in money? Absolutely not. They were betting in the relatively disciplined way that VCs do, with the pressure they have to find large deals to invest the money their limited partners provide. They take large portions of a company and make money when they hit it big on a minority portion of their portfolios.

VCs play a different game

VCs can afford to see a majority of their companies fail to meet their full promise, so long as enough of the portfolio goes stratospheric. That means a good many of the companies that get VC funding never make it big, and may even get closed down. So good times are here again for the few, not the many.

But entrepreneurs aren't VCs. If your company flops, you get nothing, so thinking that what happened to Instagram can be replicated is dangerous. More companies in tech get bought for far more modest amounts in a form of forced talent recruitment that has spawned the term acqui-hire (a combination of acquire and hire). And even more won't go that far. For example, the average paid iOS app only brings in a few thousand dollars in revenue. That's a lot of effort for thin return.

Continue pushing ahead on your plans. Just don't get taken, either as an entrepreneur or investor, by the hysteria that hits when the acquisition prices sound high. Sometimes the best way to get higher is to wait on one side of the ship while everyone else rushes to the other side.

IMAGE: Cathérine/Flickr
Last updated: Apr 10, 2012

ERIK SHERMAN's work has appeared in such publications as The Wall Street Journal, The New York Times Magazine, and Fortune. He also blogs for CBS MoneyWatch.
@ErikSherman




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