In all of the business school courses in entrepreneurship, venture capital/private equity, and finance, one of the overarching take aways is that valuating a company is not an easy task. The four major types of valuation methods we learned were the VC-method, free cash flow model, industry multiples of revenue, and using comparisons with other companies in your space to ballpark your company’s net worth. In class, the great thing about what we learned was that we used companies with predictable revenue growth/expectations, in industries that have been in existence since the beginning of time.
For example, a lampshade manufacturer is fairly easy to evaluate from an income statement and a cash flow statement. For anyone evaluating the company, you can uncover opportunities to create more value, and if inventory turns aren’t commensurate with the industry standard, you may be able to uncover additional value. For anyone looking to raise venture capital, the expectation is that the founding team maintains 60% of the company after the Series A, 45% after the Series B, and less than 30% after the Series C. In the new Web 2.0 world, I wonder if this benchmark is still accurate.
In this Web 2.0 world, the business school classroom strategy flies out the window, just as it did in Web 1.0. P/E ratios are outrageous, valuations based on multiple of revenues are unbelievable, and it’s virtually impossible to reasonably valuate a start-up, let alone a company with any bit of revenue. We have heard many months ago about Facebook being worth $15 billion, on less than $200 million in revenue, to Slide.com, the widget maker worth half a billion dollars, on revenue less than a couple million. Today, we learned that LinkedIN may command a $1 billion valuation. All early adopter Web 2.0 techies know this but the fact remains, my mother does not know what a widget is, and most students in my business school class have no idea what is a widget. In one of my favorite shows, Entourage, one of the main characters, Ari Gould says “What the [bleep] is a widget?” when his assistant told him that his widget had the accurate temperature. That response is similar to what I get when I ask most of my friends or family about widgets.
Henry Blodget over at the Alley Insider has attempted to valuate the top Web 2.0 properties, based on many different factors, with revenue/net income not being the primary driver. Interesting. With all the companies listed, I dare anyone to say that any of them makes over $200 million in revenue, but the list starts at valuations of $50 million all the way up to $9 billion.
If I brought that list to my business school professors, they would have a cow and cry irrational exuberance, deja-vu, dot-bomb, and a whole list of other permutations of late 90s buzzwords. Although I am highly biased, the Internet is here to stay, and it’s not about how much money you’re making today, it’s about the opportunities and value you’re creating to impact tomorrow. Today, my mom doesn’t know what a widget is, but tomorrow, she’ll realize how impactful it will be in advertising and distributing content. Even my mom joined Facebook today and “friended me”, something I would have never imagined in my wildest dreams just 18 months ago. The Internet is moving fast, and there are still so many untapped opportunities.
Henry Blodget did set himself up to be a topic of major conversation, but I commend him for getting the conversations started. With a weakening economy that still has yet to hit the bottom of where it’s going to go, it’s encouraging to know that social networking spending will continue to increase, to help fund the next generation of disruptive companies. I’d probably get roasted for saying this, and I am highly biased, but revenue should not be the primary driver of Internet valuation today, it’s the potential value that has been created to impact our lives tomorrow. Silicon Valley has understood this, and keeps to fund these projects out West, let’s just hope that in places like Chicago, our VCs can see the potential value that’s being created and take calculated chances to affect change in our tech landscape.