There has been an influx of popular startups that raise large amounts of money through Angel investments, and then on to seed money, depending on how popular the product is. Products like Instagram, Foursqaure and Quora, all had large valuations but not a dime in profit.
But what these companies do have is user growth and product development- which are bragging rights to sell investors another round of funding and a billion dollar valuation, in some cases- *cough* *cough* INSTAGRAM!
I always wondered why a company can be valued at $500 million without proving- or at least showing an ability to monetise the product to satisfy investors or show some promise at least. It is not on heard of for popular products to die down, it’s a big risk.
But the big money is in not making money at all, let me explain- by having no revenue figures, the companies value cannot be calculated against those figures thus creating an illusion of value as Nick Bilton of New York Times puts it. As an example of how acquisitions go with revenue equals the Huffington Post which was bought for about $315 million buy AOL, which at the time was 10 times the revenue of Huffington’s Post.
What if the Huffington Post didn’t have any revenue? and used their 25 million unique visitors a month and fast growth rate to push for a $500 million valuation? AOL may have caved in and bought it at that valuation because they have no revenue figures to go buy.
The same way Facebook had no revenue figures to go buy when they acquired Instagram, all they knew was that Instagram was wildly popular with a great user retention rate. Well, Huffington Post had the same thing, the only difference is that Huffiingpost where making money and were profitable so they were figures laid out on the table. So there was no guesswork on AOL’s part the deal was quite simple.
On the other hand, Huffington Post may have been undervalued if they weren’t making any money, so it is a gamble on both ends of the deal. In Instagram case, is wasn’t much of a gamble, there is no way they could have ever made any revenue to justify a billion dollar acquistiion so it was smart of the team to leave revenue out of the equation and focus on building a great product. By the way I don’t think a billion dollars is a ridicoulous price tag for Instagram, particularly for Facebook.
What else does no revenue tell us?
Sometimes this is a clear indication that the company is looking to sell- by raising capital, a company can stay a float and build a great product and hire talent without making a cent, on the other hand a company that wants to go the distance are going to higher a CFO and get the money rolling.
However, some companies like Tumblr, which didn’t make money for a long time, where just looking for a way to monetise in a way that will benefit both the user and the company, such as custom wallpapers and other similar features they introduced. They are going to start selling ads now, which I believe David Karp wanted to avoid if he could, in many interviews he indicated Tumblr can easily make money from ads but they wanted to find more creative ways of monetising first, that ads where a ‘last resort’ to creating revenue streams.
The no-revenue acquisition creates a finer line between gambling and investing; and of course creates more chatter about a possible tech bubble, which Chris Dixon articulately shuts down, arguing that the technology sector is trading at a reasonable 17 P/E.