musings about entrepreneurship & life…
Article originally published on December 2012 in The Next Woman.
Living in Boulder, CO has provided me with a number of gifts: the ability to enjoy nature, ride my bike, ski wonderful trails and live rurally. If not careful though, life in Boulder can also contribute to a skewed view of the world. As a town with an incremental presence of startups, one can easily observe the emphasis placed on outside investors, first mover advantage, early market share, and accelerated growth as best startup practices. From an economic development standpoint, young people riding on their townie bikes brag about their recently acquired jobs at “high-growth” startups. A couple of beers later, you learn that salaries at such positions barely cover rent and food. Beer money? I am not sure where it comes from. It might come from the future value of the stock options these youngsters have brewing on their hiring paperwork. Talk about intangible assets !
How much do “high-growth” startups contribute to economic prosperity and overall economic development? Let’s briefly look at a couple of examples Americans know fairly well: Facebook and Evernote.
On a recent Wall Street Journal article, Duke professor Aaaron Chatterji makes an interesting distinction between the economic impact of small businesses and that of startups in the US. Indeed, a high-growth startup such as Facebook has in many ways revolutionized the way companies reach their target audience. Facebook has indeed created a whole new “unquantifiable” market place that can’t be compared with the economic impact of a hardware store. But, how do we truly quantify both the economic impact and success of a company such as Facebook?
Technically speaking, Facebook as a company employs about 3,000 people. Evernote lists on LinkedIn as a company with an upper limit of 200 employees. Compare these numbers with companies such as General Electric or Home Depot, which employ over 300,000 people in a wide array of functions. Why should we care about the phrase “wide array of functions”? Because it is absurd to create a “developed” world where only software developers and product managers can afford rent and food. Not all Americans have the opportunity to even pursue a college degree. A software developer friend of mine recently told me: “Adriana, get over manufacturing outsourcing. It is a done deal”. Well, I just can’t get over it. Manufacturing does create wealth for all types of people otherwise China wouldn’t have trillions of dollars in reserves!
From an economic development standpoint, I am more inclined to align with the ideas presented by Harvard’s economist Tyler Cowen’s in his latest e-book “The Great Stagnation: How America Ate All The Low-Hanging Fruit of Modern History”. He argues that the Internet is wonderful when it comes to generating “cheap fun”. With regards to economic development however, the Internet is actually not employing many people or creating much growth as most high-growth startup’s jobs are performed more or less automatically by software and by servers, of course with programmers in between. As such, one could argue that the online world is rather not impressive when it comes to generating job growth.
With regards to financial resources absorbed by a company such as Facebook, the company raised about $2.24 billion dollars before going public. During its IPO the company raised about $16 billion dollars on the sale of 421 million shares. As such, our society has “invested” about $18.24 billion dollars on a company that sells advertising and games with an unclear monetization strategy for its increasingly mobile user base.
What makes Facebook have a market value of $104.2 billion dollars? What makes a company such as Evernote have a private valuation of $1 billion dollars?
With regards to Facebook, as pointed out by John Cassidy in his New Yorker article, “you have to assume that, within a few years, Facebook will be making not the billion dollars a year in profit it made in 2011 but five billion, or ten billion dollars”. It is still unclear how the company will effectively monetize its million upon millions of users in order to reach this goal.
Phil Libin, the co-founder of Evernote points out in his November 2012 Inc article that private company valuations are not really a reflection of market consensus. A private valuation is really “the highest price a single buyer – the lead investor – will agree on ”.
I love Evernote passionately as I use it every day. Despite my love, I don’t actually pay for a subscription and I fail to understand its billion-dollar valuation. I guess it would help to know how future profits were discounted by risk and inflation. I believe it is obsolete to calculate risk rates in a constantly changing global economy.
According to Libin, “a one billion dollar valuation today assumes a business value of $100 billion in a few years”. In a 2011 video found in the technology database Crunchbase, Libin talks about Evernote having 8.2M total users and adding 26,000 users/day. With regards to actual paying customers, it seems that the company had about 300,000 users paying monthly for the premium product version, bringing about $1,000,000 or so revenue per month. Let’s assume these statistics belong to December 2011. Let’s also assume that subscription prices remain fairly constant. Assuming an aggressive premium user growth rate per month of 20%, Evernote would have had revenues of about $47.5M in 2012. This implies that in their last May 2012 investment round, the company had a valuation of about 21 times 2012 revenue. Can a company sustainably grow its paying customer base at 20% monthly? Keeping this growth rate for an additional 24 months will bring about 3.7 billion dollars in annual revenues by December 2014. I still don’t understand how the company becomes a 100 billion dollar business in a “few” years. As mentioned previously, I love this company. I just have no idea how we currently perform valuations. As a society, we can’t be carried away with billion dollar valuations as a norm. I look forward to the predicted end of 2013 Evernote IPO. It will be an interesting one to watch.
In Facebook’s case, who were the winners of the company’s excessive valuation?
According to Bloomberg, investors who bought equity while Facebook was still private did really well during the IPO (unlike the average investor such as yourself who as of today has lost about 40% of the original investment). For example, Goldman Sachs sold 24.3 million shares, which raised $924 million at the IPO price, doubling its original investment. Greylock Partners made 18 times its initial investment, selling 7.6 million shares for $289 million. Microsoft sold 6.6 million shares, which raised $249 million, more than quintupling its initial investment.
Unless you are a preferred shareholder who has access to special liquidation preferences, I would argue that accelerated growth and billion dollar valuations don’t quite benefit the society as a whole.