Some Thoughts On The IPO Market For Web Companies

We have an IPO market for web companies again. I don't have all the names in front of me, but this year has brought IPOs for Pandora, LinkedIn, Groupon, Zynga, and TripAdvisor. These five companies are all trading for north of $1bn market cap. Pandora is at ~$1.5bn. LinkedIn is at ~$6bn. Groupon is at ~$15bn, Zynga is at ~$7bn, and TripAdvisor is at ~$3.5bn.

We can (and surely will in the comments) argue about these valuations. Some will say they are too high. Some will say they are too low. That's what makes a market. But in the aggregate, these valuations do not seem ridiculous to me. The public market investors are valuing these companies at prices that have some rationality to them.

What is possibly more interesting is that the public markets are valuing these companies at less than the late stage private market might value them at. Again, I don't have the data in front of me (I'm on vacation), but I believe that some of these companies had private financings at our above these current market caps.

The past decade (post Internet bubble, post Sarbox) brought a new normal to the late stage venture capital market. Companies are staying private longer. They are doing multiple rounds of growth financing privately. And they are doing multiple rounds of secondary liquidity for the founders, angels, and early investors. Mike Moritz calls these financings the "new IPOs".

This "new normal" is allowing these companies to stay private and develop into real businesses. With a lot of revenue. The five companies I mentioned at the top of this post will have close to $5bn in revenue this year. The company with the least amount of revenue is Pandora which, as of its last quarterly report, is operating at a $300mm annual revenue run rate.

These companies also have built sophisticated management teams that are highly capable of managing a business to meet the expectations of public market investors. They have strong operating executives, strong financial executives, and strong product and engineering leadership. They should be well run public companies.

The five companies I mentioned at the top of this post are carrying a combined market cap of $33bn. So they trade at an average of 6.6x revenues. And that is not including the cash they have on their balance sheets. I am not going to do the math, but I would bet if you back out the excess cash, you might see revenue multiples of less than 6x for this cohort. These are full valuations in a historical context, but these are not crazy valuations. If these companies can continue to grow at the rates they are currently growing, and if they can generate significant cash flow from their businesses (some of these companies already are doing that), then they should be more valuable in the next couple years, generating gains for the public market investors who hold the stock.

When Zynga was pricing its offering last week and getting ready to start trading its stock, I got a note from a friend who said "let's hope for a '99 style first day pop." I responded that was the last thing I wanted to see. And thankfully we did not get that.

It is not healthy for companies to trade at prices well beyond what they are worth. It puts incredible pressure on the team to deliver results that can't be delivered. And when the stock inevitably comes back to reality, the team feels like they somehow failed. Morale is impacted. The whole things is madness. And who benefits from that first day pop? Only the best customers of the banks who led the offerings. Why should they get a windfall when they did nothing to build the company and when they will be out of the stock so fast it will make your head spin?

The IPO market for web companies we have right now is rationale. We can argue whether it is pricing thse offerings correctly. But it feels about right to me. I believe we will see a bunch of IPOs next year, led by Facebook, which is the poster child of this whole "stay private longer" movement. If we as an industry can be patient, keep our companies private longer until they are truly IPO ready, then we should have a sustainable IPO market. That's where we seem to be headed. Let's not get greedy and screw it up.

Disclosure: USV has a significant holding in Zynga therefore I am long that stock through my interest in USV.

#stocks#VC & Technology

Comments (Archived):

  1. Kevin Selle

    Fred, what is your response to the following? Facebook will never go public because they don’t want, and will not be able to stand up to, the extra scrutiny that will come from doing so. Thanks.

    1. William Mougayar

      My take on why Facebook is not going public yet is related to a point that Fred made, which is that – they are still valued higher as a private company than a public one. They are probably waiting until the reverse becomes totally possible and true.

      1. pointsnfigures

        Facebook will go public.  I hate to see huge pops in stock on the opening day of an IPO.  That tells me that the investment banker handling it mispriced it-by not gauging demand for the stock correctly (which I would agree is a tricky thing to do)  However, they need to have a better idea than finger in the wind.  I also recall what an investment banker told me in 2001 when CME was looking to go public.  I asked, “How do you support the stock?”  Reply-“We supported this stock.  Opened at 20, ran it up to 90.”  I asked, “Trading today at?”, “20” was the reply, “but we made money.”

    2. fredwilson

      they are going public next year. it is clear from many of the actions they are taking and the comments they have made.

    3. Aaron Klein

      Replace “will never” with “would prefer not to” and you’re right. They’ll do it because their quantity of shareholders gives them all of the scrutiny of being public without the benefit.

  2. William Mougayar

    At 2.59 price/sales ratio, this makes Zynga a great buy opportunity… 

  3. Dave Pinsen

    In a recent guest post I looked at the hedging costs of most of those recent tech IPOs. Pandora was the most expensive to hedge by far. That could be considered a potential warning flag.

    1. fredwilson

      i thought it was almost impossible to hedge recently public stocks

      1. Dave Pinsen

        You do have to wait until there are options traded on them. If memory serves, that was the case for those stocks within a few weeks of their IPOs.OT, but did you find a way to get your wine to your ski house?

        1. fredwilson

          nowe bought locallyit’s against the law so we aren’t going to do it

          1. matthughes

            I hope ‘The Greatest Snow on Earth’ spicket turns on for your trip.

  4. Mordy Kaplinsky

    I wish there was a more market based method for the pricing of an IPO, so that the benefits of going public are almost entirely received by the company instead of the bankers and their private clients.  There’s some discussion about Facebook pulling off such a move for its anticipated IPO and if successful perhaps a system like that can be institutionalized for use by more web companies, or other types of companies for that matter.

  5. William Mougayar

    There are no issues with quality companies going public. The problem with 2000 is that bad companies with very little (or no) revenues were going public. I know that history very well as I managed (and created) the “B2 Index” (Business 2.0 Internet Index), a tracking index of the Internet public companies during 98-2000. And we used to come-up with all kinds of new ratios to try to make some sense of the crazyness. These companies you mentioned are trail blazers in their own segments, and they deserve to have the power to inspire others. That power is given to them via these valuations (and cash) which lets them continue to fulfill their missions and take them to even higher grounds.

    1. fredwilson

      i agree with that. i was on the boards of some companies that went public in 99/00 and they were not ready. i learned that lesson the hard way.

    2. Jon Olick

      When doing a valuation, you have to ask yourself as to the longevity of some of these “trail blazing” companies. Are these companies going to be around for the next 10 years and stay at the edge of the every changing tech wave? Or will they be outdated just as quickly as they became relevant. If the answer is that they will likely be replaced, their valuation doesn’t make sense. Who in their right mind would invest in something which has no lasting, renewable value? For example, Zynga makes highly profitable, but entirely crap games.And if you think Zynga can somehow morph into a high quality game company, your wrong. This just doesn’t happen when it comes to companies that put out crap. Companies tend to slide down from quality to crap, and it takes a Steve Jobs to push it the other direction. They don’t have a Steve Jobs, and never will. Companies like these are just waiting to be replaced by other companies who know how to do it right – and make a profit.

    3. JamesHRH

      In 2001 I was living in Calgary AB and making a living as a startup executive – basically, I was helping teams get from where they were to the next level.At an tech industry BBQ (what else?) I was verbally attacked by the EA of a friend who was a regional Sales VP at Compaq. She had stayed with the mothership and passed on the startup insanity (and thought that made her smarter than the average bear, I guess).She basically asked me if I was starving to death.My answer: ‘Why? I see as many quality opportunities today as I did in ’98 or ’99. I just see way fewer horseshit deals getting money thrown at them.”

  6. EmilSt

    Having last round valuations from VCs higher then the public market valuations is good news for me, because they know more about the potential of this companies. They know the industry, the companies, the teams much better then the traditional investors. And still have paid more then everyone can pay today. So the IPOs will prove reasonble and continue to pour money into the startup world.

  7. RichardF

    I really like TripAdvisor, it’s just easy to use for mainstream usersFoursquare should take a leaf out of their book and allow users to search locations on their website without the requirement to log in. Correction – I see they do but it’s not super obvious on the home page

    1. fredwilson

      totally agree. i have been advocating a strong logged out experience with the team for a while. they understand and are headed there

      1. Adam Besvinick

        A strong logged out experience was incredibly helpful for assimilating users to Twitter and would be even more useful on Foursquare

      2. LE

        ” i have been advocating a strong logged out experience with the team for a while”Let me step out of my area of knowledge for a second here since I’m not in a position to exactly know the relationship between a VC and it’s investments other than what I think is true based on what I have observed or read about. I’ve seen various tempered thoughts like this here and elsewhere that makes me believe that the relationship between a VC and an investment they make is similar to a therapist and client. – Can’t be to pushy. – Nicely but not strongly suggest something. – Don’t want to appear to harsh or you would be branded as controlling. – Don’t want to go out on a limb and recommend something that might come back to bite you if it doesn’t work.- Wouldn’t appreciate if other investors created a situation where there were to many chefs in the kitchen. – Want to remain friendly to encourage deals with other entrepreneursEtc.So you’re operating with two hands tied behind your back essentially.While I can understand all of that, I think it’s sad when, as you say, “i have been advocating a strong logged out experience with the team for a while” that has not been implemented. Especially based on a few comments here about something simple that to me (and @RichardF:disqus and others) is an obvious shortcoming).  And I can guarantee also that we aren’t unique (as you also mentioned) in the opinion of the lack of the strong logged out experience.  Now I’ll assume that when you made the suggestion they had a really good reason why they didn’t want to fix when you suggested it multiple times (which as you said “for a while”, not “two weeks ago”.)Although it might appear that I am criticizing I’d like to know more about the dynamic going on here that to me at least appears to be walking on eggshells.One thing I do have experience with over the years is the following. Successful people will tend to get all the advice they can from people who know more than they do. But I’ve noticed that many of the younger entrepreneurs that I’ve come in contact with seem to think they know better and would rather reinvent the wheel. That the conventional wisdom doesn’t apply to them. The same thinking is what certainly contributed to Steve Jobs dying apparently.

    2. LE

      “search locations on their website “”Correction – I see they do but it’s not super obvious on the home page”It’s a really bad experience though as it stands.  For example in the town I am in if you search for sushi you get a list sorted by check ins.  The first hit is an upscale supermarket.The next 9 hits are restaurants over the bridge in the city.  And obviously the search icon on the home page doesn’t standout and there is no excuse for that at all.That’s easy to fix. Big box that says “Search for something near you” or equivalent. Not a magnifying glass.

      1. RichardF

        exactly LE, the search icon as it stands is completely insufficient.

  8. Aaron Klein

    I could not agree more about the consequences of an IPO day pop. The media likes to play the lack of one as a reflection on the company. The reality is that it means the company got a great deal for its shares and has room to grow the valuation.Whether public or private, an overly high valuation equals monstrous pressure. It’s not a CEO’s friend.

  9. Aaron Klein

    (Edit: Weird. The comment I replied to is now gone. It was something about “why don’t we have a better IPO process that puts more money in the hands of companies and less with their bankers?”)Yep. Google did this well. I wish tech would lead the way and force this with Wall Street.

  10. LIAD

    It was only after reading a Henry Blodget post on the day of LinkedIn’s IPO (  did I understand the reasons why an IPO day pop is bad for all concerned. Counter-intuitive to say the least.Shame there isn’t a good 101 dummies guide to the workings of public markets.

  11. ShanaC

    A) Congratulations and thank you for your disclosure.B) There has been some speculation here that sarbox killed off small cap ipos.  Is the fact that we no longer see those good or bad for the venture market?  (for slightly less mature but still there small cap companies)?  Beyond M/A what does it mean for these venture backed companies?

    1. fredwilson

      i think the jury is outsmall cap IPOs have been replaced by late stage growth financingsnot sure if that’s a good thing or a bad thing

      1. Dave Pinsen

        Not sure how common it has been in the last few years, but there have been some tech cos that went public as nano caps at far earlier stages. There’s one in Western Canada I mentioned to you a few years ago. Still small, but a real co w/ earnings.

      2. ShanaC

        I’ll take a wait and see approach then.

  12. kenberger

    The [tech] IPO is dead. Long live the IPO.Most of us would agree that Sarbox was an evil thing. But it, and some other factors, brought us here to a relatively self-policing system where many more companies that really shouldn’t go public, don’t.

    1. kidmercury

      sarbox just priced people out, tilted playing field further towards incumbents. 

  13. Mike Kijewski

    I’d be interested in looking at the numbers for this group of companies minus Groupon. I don’t have a good feeling about the long term viability of that business, but I’m sure they contribute a large fraction of the $5B in revenue cited above. But I agree. The valuations aren’t crazy overall. Just Groupon’s 🙂

    1. fredwilson

      if you back out groupon’s $15bn market cap and $2bn run rate revenue, then you get to $18bn of market cap and $3bn of revenue. you are at 6x revenues. if you back out the cash, maybe you get to 5.5x revenues. i agree its a slight safter cohort without groupon

      1. Dave Pinsen

        Recalculating the numbers as of today, it turns out that Groupon is now the most expensive of the recent tech IPOs to hedge. These are the costs of hedging these stocks against greater-than-37% drops over the next several months, using optimal puts (I’m using 37% here because Groupon is too expensive to hedge against a smaller drop). These costs are presented as percentages of position value:GRPN: 35.5%***LNKD: 8.23%*P: 17.7%**ZNGA: No options traded on it yetTRIP: No options traded on it yet.By way of comparison, here are the costs of hedging a couple of established tech cos against the same 37% drop:GOOG: 0.42%**MSFT: 0.94%****Based on optimal puts expiring in May**Based on optimal puts expiring in June***Based on optimal puts expiring in JulyThe screen cap below shows the optimal puts for GRPN and their cost.

        1. JLM

          Very keen analysis.  Real good info.  Thanks.

          1. Dave Pinsen

            Thanks, JLM.

    2. pointsnfigures

      If you notice Lightbank’s seed investment activity it has all been into companies that can build a ring around Groupon if successful.  Network effects are powerful.  We will see what happens.

  14. JLM

    I would be very cautious to characterize the companies which are herein discussed as not really “tech’ companies but rather “web” companies.  And perhaps more fairly “social media” web companies.There is an element of customer base, size, cleverness and market penetration at play here but as social media web companies they are also susceptible to the “next best thing” — Groupon being my favorite candidate for a business which has spawned its competitors like ants.While Groupon has a huge installed base of customers, its product is subject to a quite fickle public who will follow the money to the next best thing with the flick of a key stroke.  There is no cogent argument for brand loyalty and the merchant deal is horrible financially for the merchant.Ratios for securities valuation which dodge the necessity of translating numbers into some return on invested capital and real EARNINGS are a fiction created to provide support when looking at earnings is simply not attractive.Though that is a legitimate technique when comparing one company to another, it is not necessarily the right technique as to why to own a stock for the long run.The financial attractiveness of a VC’s exit from an investment through an IPO is not a fair commentary on the long term investment potential of the underlying company.In an American Lost Decade of ridiculously low interest rates perhaps the rules for security analysis are changing to come into conformity with very, very low cash return expectations, but who knows?Dr Koop, anyone?

    1. Aaron Klein

      The day $GRPN went IPO, I tweeted something like “GroupOn is sitting on the razor’s edge of being a great company or a disaster. It all depends on how they innovate from here.”I have to think “deal of the day” is just a way to bring new customers on. You have to build out a bunch of innovative products and become a next-generation commerce company if you want to be sustainable.I’d have kept it privately held until I figured that out…but I guess I’m old school.

    2. JamesHRH

      The listed companies are consumer brands, powered by web tech.As such, they are currently category leaders. 3 questions remain:- is the category a long term profit pipeline?- is the leader entrenched yet?- is the category open to substitution / flanking?I like Li long term. I just spent 30 days in Europe – we used Trip Advisor continuously to great affect.I don’t game or coupon. I haven’t dug into the spaces. Both have trouble, I think w questions 2&3.

      1. JLM

        You mentioned two dirty words — category and profit.In some of these instances, the category has been totally manufactured and thus a category killer is someone who has made up his own category and then annointed himself as the category killer.I dig travel very much as a category but Trip Advisor is providing a service that as it applies to a single property may not be authoritative.Profit — nobody really wants to talk about profit.I suspect that in the immaturity of the financial model of these companies not very much is really known about the nature of their capital base.  I have a sense that their true capital infrastructure has a 3-year life and their technology has a 2-year life. That scares me from the perspective of how much cash must be committed to maintaining the corpus rather than adding customers.

        1. ShanaC

          I have heard that groupon is already running out of cash.

          1. jason wright

            I’ve heard that Google may tender an offer to buy Groupon.

          2. Tom Labus

            It’s a daily deal at 70% off.

        2. JamesHRH

          It is hard to imagine a network effect value proposition that has trouble scaling into profit. The cost structure is so low.With Li, the keys are the uptake of the revenue generating services and their likely long term penetration.Twitter is the same – I liked Fred’s belief that native revenue models are the best solution for a lot of network effect companies (like Twitter). But some of these names don’t hit that mark (GRPN again).Trip advisor is not marketed as a 360 view – but neither was Frommer’s or Lonely Hitchhiker of the MIchelin guides. They built trust and created value in the brand through meeting or exceeding expectations.I would see that as very possible for Trip Advisor. Stuck in crazy traffic in Amsterdam on the day Sinter Klaas arrives (Nov 13th – ever street blocked it seemed), with 2 hungry kids and a desire not to eat lousy food, TripAdvisor came up with and it was terrific – just what we wanted.I don’t know how they generate revenue etc., but the brand experience for us leads me to believe they can own the ‘crowd sourced online travel guide’ category, quite handily.If you believe the long term cultural impact of the internet the way Marc Andreesen (‘it eats entire industries’) or Stewart Butterfield (‘on a par with domestication of animals’) do, a global consumer brand built on a network effect mechanism, with any kind of revenue model, is more likely worth $10B that $100M.No?

          1. fredwilson

            “It is hard to imagine a network effect value proposition that has trouble scaling into profit. The cost structure is so low.”this is an excellent insight. the issue that bugs me about some of the networks we are invested in is that their cost structure is getting up there. it costs a lot of servers and bandwidth to operate a large scale network. but beyond that, the costs should be kept low. then whatever monetization technique is adopted should be able to cover the costs and generate good operating leverage.craigslist is the model i look at all the time. 80% operating margins!!!!!!!!!!!!!!!

          2. JamesHRH

            Well, – without the menace that is details! – the first answer seems to be that some native revenue streams will require direct sales / customer support (unlike a DIY service like Criagslist).The question then goes back to something you have posted about before, what is your Acq Cost v Life Value?Unless people are just getting fat & happy on you!!

      2. Partner Source

        JamesHRH, I really like your take on this, so you obviously get a like from me.I can shed a little insight on this topic as well. We have noticed that many of the privately held companies that use us for appointment setting have recently asked us to conduct B2B Surveys to feel out the possibility of them going public. Many of these companies are very profitable and well known. I wonder if the marketplace is ripe for this kind of activity as we hopefully near this rescission?*Maybe they know something others don’t know about peoples willingness to invest right now, not sure? I thought it would be of value to mention for this article as none of these companies communicate with each other, but they are all asking us to do the same thing at the same time.Glenn Wright | VPPartner Source (US Ranked #2) Lead Generation | Appointment Settingwww.thepartnersourceDOTcom

    3. Tom Labus

      The hunt for returns above low rates gave us Lehman to MF.  It probably goes back LTCM.MF was stuffing clients cash reserves into Euro bonds and fighting to keep that available. 

    4. Guest

      As wise folks say, well played JLM.   ~Geoffrey

    5. Ben Apple

      I think these should be categorized separately as web companies rather than tech.  And can these web companies remain relevant and sustainable over the long term?  Obviously technology changes quickly and tech companies have more of the ability to shift themselves into whatever the market demands, but web companies are really just pigeonholed into their market.  Except for google, which is amazingly innovative, but I have trouble seeing a companies like Groupon survive over the long haul. I just think about all the failed web companies the first time around, but that brings up another discussion, maybe the web is a much more sustainable environment now, suitable for these goliath internet companies that will dominate market share.  Otherwise, I still have to believe past history which tells me that many of these web companies will be overtaken by the latest and greatest, the “next” facebook and google.Of course, This is why its important that Fred points out that Zynga not pop into unreal territory, and why its smart that Facebook has built up their business, and showed us they truly have staying power and dominance in the web.  Let’s not blow up the market this time around!  

  15. JimHirshfield

    The first day pop is the buzz that wall street wants, and loves to exploit. The “product” is no longer the company, or what they make, but the stock itself. It’s false and contrived marketing. I wish there were an alternative way to take companies public.Another point: I think the private markets leading up to the IPO see more value in the companies because these investors are long-term focused. Public markets aren’t.

    1. JaredMermey

      Last point is true and potentially scary if companies feel the need to succumb to public investors which in turn influences product decisions. Not every company has a Bezos to play the long game.

      1. JimHirshfield

        True, but I hope that they do have Bezos’ long view; we need more of that and less pressure to succumb to quarterly results.

      2. matthughes

        Succumb is a good word to use when describing IPO’s. 

    2. Aaron Klein

      That’s why I’m a fan of both Google and Amazon. Refusing to give “guidance” for the quarterly earnings game and telling investors “we are in this for the long haul…you need to be too” are both tactics that I’d be very inclined to follow if I ever lead a public company.

      1. JimHirshfield


    3. JLM

      The first day pop is bit like rooting for the lions v the Christians in the Roman Coliseum. You like the drama of it all but you really know in the end that damn few lions get to retire to the Amalfi Coast.

  16. AVCoholic

    Excellent post!

  17. andyswan

    Wild and potentially dumb analogy warning:In the book “Starting Strength” that I put on my list last week…the author does an amazing job of making you understand the value of positive, consistent momentum.  Figure out what weight you could do 5 reps at “comfortably”.  Do it 3 times.  Next time you do that exercise (4-5 days later), add 2-5 pounds.  5 reps 3 sets again.  Add weight next time again…continue until you fail to get all 15 reps on 3 consecutive sessions.  At that point, drop weight 10% and start again, completing sets, getting positive, adding weight, creating momentum.You WILL breakthrough what would have been barriers had you started at or above 100% at the beginning.I think the same can be said for pricing your “rounds” as you raise money.  Build momentum for your team, build a paper-profit for your investors.  Create momentum and get consistent small wins all the way up the ladder….give yourself breathing room to scale-back, tighten up and regain momentum every once in a while.I know it’s a stretch of an analogy, but I’m dealing with a few companies right now that might have gone “too heavy” early on and are paying for it now with backwards momentum that is VERY tough to reverse…I’ve never been captain of an IPO ship (yet!), but I’m sure the same applies for those that are truly committed to long-term growth for shareholders. The best entrepreneur I’ve ever known was most worried when “our stock is too high”….

    1. Aaron Klein

      I think that’s a great analogy.Jim Collins wrote much the same thing in his latest book, Great by Choice…the companies who have outperformed over the long haul are the companies who consistently hit the same simple performance goals (e.g. X% growth quarter over quarter) in good times and bad.He calls it doing the “20 mile march”…great excerpt here from Fortune Magazine:http://management.fortune.c

      1. andyswan

        I got to speak to one of the founders of TD Ameritrade, which started as a mom-and-pop broker in Omaha in the 70’s.I was struck by how he said he and his dad built and grew the business: “Just deliver a 20% ROE for 25 years.”Now they own the Chicago Cubs.

        1. Aaron Klein

          As impressed as I’ve been with the Ricketts for their success with building TD, I will be REALLY impressed if they can do the same for the Chicago Cubs.Speaking of which…attention Cubs fans, opening day is only a few months away. That’s the day you’re always tied for first place in your division!

          1. Dave W Baldwin

            @andyswan:disqus you know I’d like to make a comment… 😉

      2. andyidsinga

        Aaron that link was an awesome read! (now I gotta go get the book)

    2. Dave Pinsen

      Seems like a solid analogy to me, not wild or dumb. 

    3. ShanaC

      Seems like solid advice, but I would take the weightlifting advice with a grain of salt and go slower.  You can cause injury if you raise the weights that quicklyI suppose the same could be true for building businesses.

    4. Ben Apple

      How much does facebook squat?

      1. andyswan

        60,000,000,000sent tomorrow from my DeLorean at 88mph

  18. jonathanmendez

    Important point is that the majority of revenue from all these businesses is online advertising. 

    1. ART

      False. Zynga makes most of its revenue from Virtual Goods, Groupon makes its revenue from direct sales, and LinkedIn makes money from subscriptions and hiring solutions services.  

      1. jonathanmendez

        i should restate a bit – true that Zynga’s rev now is not ad supported but in 2008 during 73% of it’s revenue was. Groupon is just offers – ads by whatever name you want to call them. 1/3 of LinkedIn rev is marketing and most of Pandoras is ad. TripAdvisor is also mostly ad/affilate. So I over simplified the point originally however in aggregate for these companies I stand behind it.

        1. LE

          I would also add that zynga pandora and, yes even groupon are in the entertainment business as well. In the same sense that people buy things from QVC that they don’t need. Or buy clothing for the entertainment of shopping.  Or browse a Barnes and Noble store and pickup new books before they have finished the old books.  Or buy domain names that they don’t use (most people don’t actually use the domains they buy so in the domain business it’s a dream that is being sold).Starbucks isn’t selling coffee it’s selling an experience (Dunkin coffee is generally better but it’s a buzz kill experience same with McDonalds). Starbucks is also really a “sugar delivery system” more than caffeine.  It’s a sugar fix. (A hat tip to the Insider movie about tobacco being a “nicotine delivery system” – the real product being sold.)

    2. Rob K

      A number of the companies mentioned (LinkedIn, Pandora) have a large portion of revenue from subscriptions as well.

      1. PKafka

        Pandora’s sub revenues are very small. Less than 10 percent, perhaps less than 5 percent.

  19. Ben Popper

    Not sure I grasp the technicalities, but I thought Hunter Walker raised an interesting point. “Will late stage capital look for additional protection against valuation decreases? Well documented that last round money into Zynga invested at $14/share, substantially higher than the $10 IPO and today’s ~$9 close. Will “Series D” later stage funds look for downside protection in the future – eg warrants that convert to more shares if an IPO occurs at a valuation below their investment (a form of preferences similar to traditional venture investors)?”http://elapsedtime.blogspot… 

  20. John Petersen

    The main problem with the IPO and the initial pop or lack there of is the “P” — the fact that the “public” is now included in the equation. I even extend public to include the financial analysts on Wall St. in this particular case.The public and your typical Wall St analyst have no idea how to properly evaluate these companies. They do things like compare Zynga to Electronic Arts, Groupon to Amazon, and every IPO to Google. Add in the fear factor (fear of missing the next Google), and you have wild fluctuations in prices as the public tries to understand what they just bought and sold.I would agree that the IPO market for web companies is more rational now, but it is still a very dangerous game as the public gets its first chance to jump in (and out).

    1. Aaron Klein

      A lot of people think that the rules of investing gravity get suspended for IPOs.They don’t.An IPO stock is like every other stock, except for one thing: zero track record.I’ve always thought it was perversely appropriate that if you put an IPO stock into Riskalyze, it will tell you “we don’t have sufficient historical data to calculate that investment for your portfolio.”

      1. John Petersen

        That’s why I’m glad that Zynga opened lower. People need to be reminded that not every IPO is going to gain 50% on its first day of trading.I had an advisor once tell me that there was a new IPO coming through the pipeline and that I should call all my clients. I asked him what the company was, and his reply “It’s some utility company. I’m not really sure about all the details, but clients love to buy IPOs.”Typical broker mentality — sell them what they want.

        1. Aaron Klein

          Mark Pincus is world-class and Zynga has a great run in front of it. The stock definitely has room to grow now and that is great for the entire Zynga team and its long-term investors.And yes, that broker mentality is exactly what gave rise to online self-directed investing. The trouble is, we’ve only delivered on the execution side of that innovation. We haven’t given those investors the confidence to pull the trigger and the tools to keep their portfolio aligned with their risk tolerance.That’s exactly what we’re building with We need to restart the stalled growth engine of the online investing market by empowering online communities to create and share investing ideas, and then personalizing the impact of those ideas with my Risk Fingerprint for my own portfolio.

          1. John Petersen

            Should have clarified. I do not think Zynga is a bad company or that the opening day performance of the stock is a sign of things to come. I agree that (from everything I’ve read) Pincus is a really smart dude.I just meant that I’m glad a tech IPO finally broke the pattern of posting ridiculous gains on the first day. Sometimes the public needs to see these things to prevent them from blindly running into the next one.

          2. Aaron Klein

            I was agreeing with you…I didn’t think otherwise. 🙂

  21. Rob K

    I agree that these valuations are agressive but rational. I have seen posts on Seeking Alpha and Motley Fool that suggest it’s like ’99 again which I think are silly. These are all real businesses with multi-hundred million dollar revenue streams. Defensability may be in question, as may cash flow, but that simply dtermines where in the 3-10x revenue multiple range the company belongs. 

  22. Eric Leebow

    The “stay private longer” philosophy is interesting and some major companies never go public. I had someone email me a while back about going public before my site even launched, and I saw a few years back a web application go public in the dating industry, yet it start out as a penny stock. What’s your take on going public first opposed to waiting longer, is this the last resort for some entrepreneurs to raise funding, or are these entrepreneurs just looking to avoid a private equity financing some reason? Have you seen any of the companies that went public first reach the stature of some of the above mentioned Web companies?

  23. celestus

    Of course the private markets are going to tend to give a higher valuation.  Among other factors, you can’t short sell in the private markets (yet), so the price is much more determined by the people who are more optimistic about the company’s prospects.

  24. kidmercury

    well, not sure how this gets reconciled with occupy wall st sentiment……goldman takes these companies public, and all public companies benefit from the inflation scam which exacerbates income inequality by transferring wealth out of the dollar and into stocks. it would be nice to see entrepreneurs and investors show some interest in stock market reform. but i suppose it is irrelevant at this point, as the disruption of these financial markets is coming whether anyone wants to believe it or not. agreed these stocks and the whole market is going higher (not because they’re undervalued, but because the fed will do what it takes to force them higher), though i don’t see how any of them are good buys now and i doubt most of them will be any time soon. zynga is the closest in my opinion though i don’t think it’s undervalued which is what you want if you’re buying. for those with lots of money in stocks (“lots” being defined as a psychologically significant amount that will hurt if you lose it all), i hope you will consider taking direct registration of some of your stocks. the whole market is a regulatory disaster and direct registration provides you with some extra security against an MF Global type scenario. 

  25. Peter Sullivan

    Fred I was hoping you were going to do a blog post about the the new Cornell Tech Campus!

    1. JLM

      Huge and creative win for NYC.  This will become a landmark as important as Central Park one day.

  26. howardlindzon

    This is one of the most interesting times in markets.  from angel list to bulleting boards (what a stupid name for a ‘public company’ – the only thing i want to do on a bulleting board is pin things  that I really dont need – to public marlets that you mention may be valuing companies at less than late stage.all the inefficiencies are such an opportunity.the markets have been very correlated for a while now and these inefficiencies will finally take the sex out of handing your money to a quant.overall thats good because quant is an abused term and the real type of money manager I want is a person that can use computers to help manage a portfolio, not pick a portfolio with computers to be managed by computers.

    1. Aaron Klein


    2. Dave Pinsen

      Some quants do socially useful work. I’m meeting one for lunch today, a Princeton post doc who helped develop the algorithm for Portfolio Armor. His work with me is consistent with his academic work, which is about managing risk, not figuring out how to scalp someone slower on the draw. 

      1. Aaron Klein

        I don’t think there’s any question that you’re right. But it’s true that “quant” is an abused term. 🙂

        1. Dave Pinsen

          I guess you could say it’s become a tainted term. Incidentally, this quant worked on Wall Street prior to going to grad school for his Ph.D., and he has no interest in going back to Wall Street, even though he could make more money if he did.

    3. JamesHRH

      Quants = buy/sell & investors do name picking?

    4. ShanaC

      why are quants an abused term, and why do you want the moneymanger that picks for himself/herself?

  27. BarrySchuler

    Couldn’t agree more Fred.  There are a lot of mature stable tech companies in many categories that are ready to IPO.  We need a functional markets to support these deals and that means rational expectations on valuation and growth.  If we can keep the kind of greed that has led to past bubble behavior moderated, we can have a stable IPO window for an extended period.  That will lead to job creation, growth and a healthier economy.

  28. Denis Zgonjanin

    Late-stage private companies trade in the private market at the near-maximum of their eventual public valuation.Let me explain why I think this:If you invest VC in a private company, you are investing your money for some period of time. Since selling those shares is non-trivial (perhaps impossible depending on the terms), if you lose confidence in that private stock or become bearish about it, there is no easy way to pull out of that investment. At the same time, the private company may seek additional funding from other sources. Even though you may be bearish on the stock, as long as there are new investors who are bullish about the company stock, the valuation of the company will rise with each round of investment.In a public company, bearish investors are free to sell their stock, bringing the value of the stock down. The illiquidity of private stock means there is no way for investors to influence the price of the stock by trading it freely. The only way for the value of a late-stage private company to go down is if the company screws up in a big way. Put it another way, the valuation of a public company is the valuation agreed upon by market forces and the market as a whole. The valuation of a late-stage private company is the valuation agreed upon by the latest round of investors, all of whom are very bullish about the company. And it’s for this reason that we’re seeing that the value of a late-stage private goes down as it goes public. It’s simply market forces.

  29. PKafka

    Worth noting that the 3 $1B+ IPOs you wrote about that have been public for more than a minute (Pandora, Groupon, LinkedIn) are all trading below their first day close. That could be simply because they’re trading in line with general market, so perhaps it doesn’t mean anything. But I’m also interested to see how long insiders hold their stakes if values don’t move, and what happens when/if they sell.

    1. JLM

      You already know the answer to that question unless the Congress also repeals the Law of Gravity.This is reality.

  30. Dan Bowen

    Fred I’d love for you to help me understand the ‘value’ of companies that on the surface have never been self-sustaining without round B, C, D or IPO (which appears to push the issue onto the public market). My question is we always hear of run rates and adoption but profitability never enters the equation.  I, like many of my friends, created my first software company that I bootstrapped, built, and exited after 10 years. My company was always profitable because we had to be in order to survive (it was also in Arizona where access to capital was non-existent). As I now build my new venture, (I now live in the North Bay) and as I tip-toe into the world of VC’s, I am amazed that there is almost no talk of profitability (or even an honest path to) and instead a focus on revenue and adoption rates.  It seems profitability is an afterthought or assumed to exist as long as you have huge rev and adoption numbers. It also seems, at least on the surface, that the IPO or M&A exit is the failsafe if the ability to stand on your own never materializes because the risk and financials are clearly passed onto someone else.Groupon is perhaps the textbook example of this issue and I question whether or not they will ever show a real net after profit.  To me, Groupon has been nothing short of a Ponzi scheme but few would have ever known their game until they were seemingly forced to go public to stay alive.In the end, I feel like I’m missing part of a much larger discussion and or old Business 101 where revenue has to exceed expenses simply doesn’t matter with tech.  If that is the case, do you think it should?

    1. Alex Glovsky

      I wholeheartedly agree!  And the cynical side of me believes that there is little talk of profitability because if the exit comes – especially through IPO – the private rounds will have liquidated their investment.  In other words – what’s important is getting to liquidity, not building sustainable business models.  That is a striking thing to say, since you would think that those providing liquidity would not do so if they weren’t buying a sustainable business.  Alas, and again – especially in the context of an IPO – the sources of liquidity are themselves often seeking to play a kind of “hot potato” with the business, only holding it long enough to ride a wave of over exuberant public sentiment.

      1. Dan Bowen

        Alex I’d guess I’ve asked this question 20 different ways on other VC and industry blogs and I’ve never gotten an answer.  I don’t mean I’ve been blown off, I’ve never gotten an answer which has only made the question that much more interesting to me.

        1. fredwilson

          see my reply above. profitability is the goal. a business can’t sustain itself without profits.

          1. Dan Bowen

            While I agree with you that profitability should be the goal, it seems the majority of the most talked about tech businesses aren’t and in fact need you guys to be “sustainable”. It also seems like there is a race to be the biggest deliverer of “X” regardless of profit in order to M&A, IPO or Round X that liquidates early investors. Thank you for your stats on your 2004 fund, I assume, or at least hope, other successful firms have similar numbers.

          2. fredwilson

            There was a period a few years ago when everyone was talking about facebook’s losses. Once they turned their attention to revenues they got profitable quickly and are now spitting cash

          3. Dan Bowen

            Fred the blog didn’t let me reply to your last response so I’m just putting this in here.  Facebook is the edge of the envelope and while it highlights your point, we’re also talking about a company that had unlimited access to cash.  The same argument could be made for Amazon and a number of others. Perhaps my question would be better stated this way:Do you think there is enough focus on a path to profitability with startups or do far too many mistakenly believe they can replicate a customer acquisition model like FB which will lead to a future rev/profit model? Do you also think there is too much focus from young entrepreneurs on the quick buck? 

          4. fredwilson

            I dont think you can generalize. We work with all kinds of entrepreneurs. Some want to be profitable too soon. Others wait too long.

      2. fredwilson

        in our 2004 fund, i’d say that at least 2/3 of the companies are operating profitably. profits are the only way to make a business sustainable. it is the goal of all the companies we invest in.

    2. Guest

      Awesome Dan, awesome.  ~Geoffrey

    3. Ben Apple

      It does matter with tech!!! Anyone remember what happened 10 years ago???

  31. LE

    From a reply by Fred below:”you are at 6x revenues. if you back out the cash, maybe you get to 5.5x revenues”First, I’m not proposing that a profit multiple is the right thing to use as a multiplier. Because I don’t like any multipliers when evaluating these types of businesses.But consider this:At a multiple of 6x revenue and assuming the below scenarios and profit margin(s) the following applies:At a 6x multiple with a 20% profit margin it would take about 30 years to earn back an investment. (100/20*6 = 30) A 20% profit margin is great. How many companies have 20% profit margins – not many.At a 6x/10% it would take 60 years.At a 6x/5% it would take 120 years.Financial types always like to use comparisons of what others are doing in order to justify a number or a valuation. GE (about 10%) is valued at 14 year payback. Fedx (4%) at about the same. These are for stable businesses with, say, little upside but also no where near the downside of the above mentioned businesses.  It’s hard to say that these are overvalued though since the value is what the value has been set at by the market.  But it’s also based upon the people who are buying this stock betting that they can get out at the right time and not loose their shirt. If you want a sanity check I would ask anyone who is reading this post who owns a stable business and earning a stable yearly income if they would sell their business for 30x the amount they make in one year (assuming the asset value was nominal meaning). I think most would take that deal.

  32. FlavioGomes

    ‘If we as an industry can be patient, keep our companies private longer until they are truly IPO ready, then we should have a sustainable IPO market’Absolutely great advice…lots of pressure from key stake holders that make this tougher to do but if you stay the course it will be better in the long run.  Far to often I’ve seen really small tech companies go public (usually from a reverse public offering) and they end up transitioning back to private with a lot of open wounds.Too small with not enough market and you’re handcuffed with a stagnant under valuation. 

  33. Bala

    I don’t know about you all, but I don’t buy the way the market has been trading. There is a tsunami coming very soon and I am bracing myself. I think all these stocks will get squashed when it happens. Just sayin…

  34. Neil Kusens

    Amen!   Some excellent end-of-year wisdom Fred!   For those of us who have lived through the ’99 rollercoaster, I think we can all agree that a repeat of that would be detrimental to what us startup entrepreneurs are working towards! 

  35. JamesHRH

    ’99 style pop’ = everything that ails Wall St.A private investor told me, a long time ago, that a first day pop means your CFO can’t manage the market.

  36. Leigh Drogen

    I wonder when the inevitable blowback takes place from average investors (by way of large mutual funds) who can no longer take part in the vast majority of growth that is taking place. If a normal IPO used to take place at a valuation somewhere in the range of 500 million, and we’re now getting IPOs between 5 and 10 billion, not to mention Facebook which will be upwards of 80 billion, what piece of growth is left for the public markets. Yes some of these companies will show 4-5X returns at valuations between 5-10 billion at IPO, but that pales in comparison to the 40-50X returns of the past for the same company coming public earlier. And Facebook, at an 80 billion dollar valuation at time of IPO the best possible scenario is a 4X return. This is just the reality of the situation, and while I have no dogma as to whether it is a good or bad thing that companies are staying private longer, I am absolutely sure that there will be a large population of public investors who are extremely disadvantaged by this. The market isn’t there for any one person or group of people’s benefit, it doesn’t owe anyone anything and it isn’t meant to do anything specific, so at the end of the day I  really couldn’t care less that the strategy of companies staying private longer is going to take returns away from public market investors. But I can say this with certainty, there will be a monster backlash.

    1. kidmercury

      there will be opportunities for traders. i.e. zynga IPO’d at $10 or around there, i wouldn’t be surprised if it dropped to $5 in a broad market sell-off. buy there and sell when it goes back to 10….internet stocks are fueled by pre-IPO bubbles and so they are assets for trading when the IPO comes around. given the bubble economy we live in buy and hold is a tougher strategy for the majority of stocks and investors will need to adapt accordingly — indeed i believe they already are.  

      1. Leigh Drogen

        I agree.Though that doesn’t speak to the vast majority of investors who are passive (a broken philosophy if it ever was whole at all) and they will suffer the most. 

    2. ChuckEats

      exactly – no one wants to talk about this.the average investor can’t get into deals b/c they don’t have $1M in liquid assets.  Sarbox has contributed significantly to the “staying private” the time the companies are valued publicly, they are fully valued.

      1. Leigh Drogen

        They aren’t fully valued, but the vast majority of their growth in terms of returns has been eaten up already. 

    3. Dave Pinsen

      You raise a good point. There is a simple solution to it, but it would require an unlikely amount of backbone on the part of mutual fund managers: boycott the IPOs of companies that go public too late in their growth phase.  

      1. Leigh Drogen

        Never gonna happen

    4. Jeff Robinson

      Bingo! Somebody who gets it!

  37. Jay Pore

    Typo?”The IPO market for web companies we have right now is rationale.”

  38. John Delaney

    What explains this tendency for (non-strategic) late-stage investors to value companies higher than the public markets?  I wonder whether there is a connection between the (somewhat different) information presented to late-stage investors and these higher valuations.

    1. jason wright

      Doesn’t a company like Facebook stay private only until Goldman Sachs feels it’s about to tap out the private investment market?FB – a digital slave colony if ever there was one. The slaves work to generate all the content in return for free ‘accommodation’, while the slave master has ownership and profits.

    2. kidmercury

      the more money you have, the more things look cheap to you…..a lot of these funds are oversized. DST, andreessen horowitz, chris sacca’s jp morgan fund…..too much money to play with and so they bet too much. 

      1. fredwilson

        so true. that’s why we keep our fund sizes small. when i hear, “well we can just invest more to get to our target ownership”, i freak out

  39. MikePmalai

    Long time reader. Finally have a topic where I can jump in.  I don’t really play in IPO stocks but I figure I chime in with a couple thoughts. (I help cover public tech stocks for a large fund.)1. Staying private longer is taking a lot of the “speculativeness” out of the IPOs. On one hand, companies are more mature and better equipped to handle what the public markets throw at them…on the hand, much of the rocket ship upside is already extracted by the time the IPO comes around. If private investors think they can continue to extract material upside staying private for another year (or two), why share that with the public markets?2. There’s much more emphasis on fundamentals and the economics of the business with bigger valuations. How well does Zynga transition to mobile gaming? Or will it be Fatigueville for the company? Would investing in EA be a better risk adjusted bet to participate in the industry shift/rollup to mobile? As an investor you start asking yourself if the risk/reward profile at these multi-billion dollar valuations make sense relative to investing in other public technology companies with proven/defensible/growing models.

  40. jason wright

    Chris Dixon – “Preferred shares behave like a stock on the upside and a bond on the downside.”Like having your cake and eating it.

  41. Otto

    Do any of these companies pay a dividend? How much debt do they have versus their cash? Do they really dominate an industry or a sector? Will they dominate long term or are they just another or Home Grocer? Will they dilute the value of their stock by frequently offering new shares? P/E? Book value?I like some of these websites. But this is just IPO hype. Like Fred said, this type of IPO just makes the best customers of banks a lot of money and that’s it. They’re really not good investments for the average person at this time. The market is moving sideways and might continue that way for awhile because most stocks are too expensive (I don’t mean share price). Most stocks right now are bad for the average shareholder and rigged casino capitalism like this doesn’t help.

    1. kidmercury

      linkedin’s P/E is currently 1,262. and this is after its price has fallen by 25%. lolof course none of these companies issue dividends, they all view themselves as companies that can grow infinitely, if only they just keep re-investing profits……linkedin’s a good company though. i might buy it if it can fall by 90%.

      1. JamesHRH

        Long term position versus short term price can get pretty funny.

        1. Otto

          That’s what the market is right now. It’s like trying to follow the logic of a room full of three year old’s. There might be one genius in the room but most of it is just noise and scribbling.

          1. Ben Apple

            Just depends on your expectations and your level of risk.  WMT doesn’t have the growth potential of these companies.  However, if this is your retirement fund, not wise to throw it in Linkedin.

          2. Ankit

            If you’re a young investor and can tolerate short term ups and downs, then PEG is a better ratio than PE because it takes growth into account as well.Great businesses sacrifice short-term gains for long-term profitability, sustainability, and market leadership. Amazon is excellent at doing this. First, they did it with e-commerce and now they are doing it with AWS. If I’m not mistaken then Amazon was not profitable for the first 5-6 years?              

      2. Otto

        1262 sounds like my worst Galaga game ever, not a P/E to be taken seriously. By comparison, WMT – love them or hate them – has a P/E of 13.32 and pays a dividend. LNKD or something like WMT? It’s not hard to see where the better deal is for Joe Sixpack’s 401k.

    2. Baptiste Picard

      It’s also a matter of investor competition at the pre IPO stage. More and more investment companies want to capture the value of these web companies at this stage which can create some non rational effects, whatever the quality of the business you can get some strange effects when the company is public due to this competition that happens now earlier on.

  42. Otto

    Quelqu’un at-il effectivement trouvé un emploi sur LinkedIn? C’est le parc de bureaux ternes de l’Internet.

  43. Andrew Badr

    HomeAway as well

  44. vruz

    All is nice and well, and they have a good salesforce, yada yada yada.I don’t know about the others, but does Groupon have a good, lasting product?  Really?

  45. Lee Blaylock

    RE: Fred’s comment about late stage private sales being at a higher valuation.It is only a matter of time before the SEC inserts its ugly foot in these private market places.  When a company isn’t forced to be transparent about its operations and finances, or discuss them publicly, it is more about speculation than investing to some level.  I’m a big fan of the liquidity portion but the fact these companies are going out priced to perfection bodes poorly for their ability to find and attract great talent, b/c there’s more downside risk in their options than upside.

  46. Jeff Robinson

    “Let’s not get greedy and screw it up” Who is the  “Let’s” ?”screw it up” for whom?The only person getting screwed is/will be the average retail investor listening to and believing in all the hype buying overvalued securities for the benefit of the VC’s and the IB’sThe reason for the IPO in the first place is so that the VC’s can EXIT ( onto average Joe )

    1. fredwilson

      Screw it up for everyone.VCs can and do get liquid in the late stage private markets. We don’t encourage our companies to IPO. We can sell stock at higher prices in the late stage private markets

  47. Sandra

    Wish I had found this blog before today. The advices in this posts are very helpful and I surely will read the other posts of this series too.

  48. LE

    I’ve seen many disclaimers in posts. Although there should probably be a link to the USV investment page… on the… page. 

  49. BarrySchuler

    the one and only – the fame part: meh

  50. Rohan

    Me too..