Is $4 Billion the New $1 Billion?
The crop of new tech companies that entered the $1 billion valuation club last year, such as Zulily and Evernote, made entrepreneurs breathless. But that was so 2012. Now it's all about the $4 billion club, or so it seems.
Among the companies that have reached into this stratosphere in recent months are Pinterest, which raised $225 million in series E funding in October; Spotify, which raised $250 million in late-stage funding; and Snapchat, whose young owners swatted away a $3 billion offer from Facebook, because they thought it was too low.
Snapchat will soon eat crow for its hubris, many naysayers believe. All these developments are evidence that we are at the perilous bursting point of a new tech bubble, for which these extraordinary valuations signal the endgame, others say.
Well, maybe not. There's no intrinsic significance to reaching the $4 billion level, and those valuations could move even higher, says John Backus, founder and managing partner of New Atlantic Ventures. But until these companies bear out their values in financial metrics such as free cash and profits, it's all inside baseball trading.
It's hard to tell what math, if any, investors are using now to calculate these colossal valuations. As private companies, Snapchat and others don’t have to make their numbers public. So the usual markers that valuation experts employ don't exist.
"As a generic valuation practitioner, I would not have any rational way of determining a value" for these new tech companies, says Bruce Bingham, executive director of Capstone Valuation Services.
But valuation is as much an art as it is a science. For Backus, the $4 billion premiums are a discount to what the companies' values might ultimately be. New Atlantic specializes in technology companies, and Backus theorizes at least some of the new tech stars will emerge as the future Amazons and Googles.
Doing the Math
As the companies in question are generally consumer-facing, Backus says it might be useful to compare their value per customer with those of more established tech players.
First, Backus assigns the companies into three tiers. The first tier is the old-guard tech companies that have been around for more than 10 years, ones with established business models like Amazon, eBay, Google, and Netflix. The second tier consists of the recent entrants to the public markets such as Facebook, Twitter, and Linkedin. The third tier includes the companies that have not gone public, but which have received $4 billion valuations.
Backus then determines the value of customers for each company by dividing the company market cap by the number of users. Generally, the first-tier value per customer is about $700. For the second-tier companies, the value is closer to $100 a user, which is not surprising because the companies are newer and are still proving their business models. For the third tier, whose numbers we know next to nothing about, Backus makes some educated guesses.
For example, Snapchat says its users post about 400 million total "snaps" a day. If each individual user posts about four a day, that would mean there would be about 100 million users, Backus says. If we use our mid-tier valuation for companies like Facebook and Twitter, or $100 per user, that would put Snapchat's value at $10 billion.
In other words, $4 billion might significantly undervalue the company in today's market terms, Backus says.
Today's high-flying companies have strong user bases that can be monetized, Backus says, in contrast to many of the failed ventures during the tech bubble a decade and a half ago. "The big difference between 1999 and today is that back then the companies that got funded at very high valuations did not have much more than a business plan, maybe some modest revenues, and big ideas," he says.
Determining which of the young businesses will own a particular category, as Amazon owns e-commerce and Facebook owns social media, and which ones have the ability to scale quickly, are key question marks.
Investors are placing their bets on these companies. Whether they're right is anyone's guess. And there may be other, non-monetary things at stake. "This is partly about perception and investors who want to be associated with a hot company," says David Zilberman, a partner at Comcast Ventures in San Francisco. "To be affiliated with the high-flying companies benefits potential deal flow, and your ability to get in other investors who can't get into those rounds."