What Can It Be Worth?

The thing I always think about when making an investment is not what it is worth, but what can it be worth. To determine what something is worth, you can look at comps (which I posted about here), or you can let the market tell you what it is worth by running a process.  But the really interesting number is not what it is worth today, but what it can be worth.

For this, you need to use your imagination. When we invested in Twitter, we had to imagine that hundreds of millions of people around the globe would use Twitter to find out what was going on, and that Twitter would be able to build an advertising business around that behavior that would result billions of dollars of annual revenue, and that Twitter would be able to generate positive cash flow on that revenue, and that the public markets would welcome Twitter and value it as a multiple of those revenues and that operating cash flow. We did imagine that, although to be honest, we did not imagine as big of a success as evidenced by the fact that we stopped investing in Twitter after three rounds, which was a mistake that, in part, led to the creation of our Opportunity Fund.

So when valuing a venture stage opportunity, you have to imagine the product can scale to be used by many more people, or companies, or both, than are using it now. For that exercise, you need to study the product, the roadmap, and the use cases and be sure that your imagination is possible and not delusional. You also need to figure out what an annual revenue per user (ARPU) might be and apply that to the potential size of the market. Then you need to study the economics of the business and figure out how much of that potential revenue might flow to the bottom line.

Finally, you need to figure out how the market might value that cash flow. That’s where a comps analysis might be valuable. But you have to factor in that the market might not be valuing companies when you exit in the same way they are now.

After you figure out what it might be worth, you need to discount that back by 3x, or 5x, or even 10x, to discount for the risk that none of this might happen.

When you do all of this work, in today’s environment, it’s hard to make an investment. Because often the math doesn’t work. Which tells me that many people aren’t doing this work.

#VC & Technology

Comments (Archived):

  1. awaldstein

    Just finished How We Got to Now (http://www.amazon.com/How-W…A book packed with insanely crazy delusions, 360 degree pivots that today are the fabric of our world.It make a lot of things that sound crazy, feel oh so possible.

    1. Bob Vance

      The water innovation was especially crazy, imagine the results if his assumptions were incorrect.

      1. awaldstein

        Blown away by the book and realizing that the changes in my lifetime, in my mom’s now 96 are just so so dramatic.Driverless cars? Drones? Mesh networks with apparatus on top of vehicles? NYC going 100% electric cars?All seem very possible.Now from the business math of an investor with timeframes–a different more complex story to think through.

    2. LE

      “Six Innovations That Made the Modern World”It make a lot of things that sound crazy, feel oh so possible.It is important to realize there are a billion things that never led to anything at all. [1][1] I mean I guess it’s good that Bruce Springsteen or Adele practice hard and followed their dreams but there are a million others who are waiting tables and can’t afford to pay for healthcare by doing the same.

      1. Joe Cardillo

        Which is not a problem unless you are hell bent on seeing the outlier as the median = )

      2. awaldstein

        read this book.read about how the photograph was first designed to be something to listen to voice messages and the telephone to do a one to many broadcast of music.or about how the ice business out of new england developed.amazing stuff.

        1. falicon

          The ice business story was one of the most interesting to me throughout that book…shows the importance of so many entrepreneurial traits, especially perserverance and pactience.

          1. awaldstein

            yup quite a story.most liked the beginning–where they figured out how to get it there without either creating storage or a market–and the end where this went away when refrigerators were invented.

  2. Adrian Bye

    that makes it more exciting!

  3. LIAD

    **Just to get this party started**alternatively people *are* doing the work and arrive at a larger number because they dream more freely, discover more use cases, arrive at a larger market, unearth ways to achieve a higher ARPU and take a smaller risk discount.Bastardising Churchill’s/George Bernard Shaw’s idiom:”if you’re not magnificently optimistic in your 20s you have no heart. If you’re still magnificently optimistic at 40 you have no brain”

    1. Matt A. Myers

      At a certain point you’ll need to be able to realize what’s (realistically) possible, and that mental energy you have will go into clear and careful planning – there is no space for creative energy exuding in unruly or illogical ways; this is the dilemma of idea vs. execution.

      1. JLM

        .This is exactly why the guard rails for creativity have to be a well articulated Vision, Mission, Strategy, Tactics, Objectives, Values and Culture.When an entrepreneur does that work, the friction loss and the wasted energy is reduced. This is the power of alignment.I have seen this done so many times it is legendary and yet I also see creative people who spend all of their time getting ready to get ready to be creative.JLMwww.themusingsofthebigredca…

        1. Matt A. Myers

          Guard rails, constraints – yup, and narrowing a vision creates or causes context.

          1. JLM

            .Don’t think of “narrowing”, think of focusing and strengthening.A laser is just a very focused powerful light. And, yet, it can cut steel, no?Be a laser or be a streetlight?Focus.JLMwww.themusingsofthebigredca…

          2. James Ferguson @kWIQly

            Technically No 🙂 – It is also coherent …From wikiSpatial coherence also allows a laser beam to stay narrow over great distances (collimation), enabling applications such as laser pointers. Lasers can also have high temporal coherence, which allows them to emit light with a very narrow spectrum, i.e., they can emit a single color of light. Temporal coherence can be used to produce pulses of light as short as afemtosecond.But yes – think both well timed and focussed and you end up with intense !

          3. JLM

            .I don’t know too much about lasers but I am extremely adept with a laser pointer. When we meet, I intend to blind you in your left eye with one. (Assuming you are right handed, mind you.)JKJLMwww.themusingsofthebigredca…

          4. James Ferguson @kWIQly

            Looking forward to it with 20:20 foresight !so when done we can reflect on it with perfect 20: hindsight ;}The point however of the pointer analogy is neat. It requires both resource plus focus and synchronisation to deliver powerfully on targetTL;DR – Your analogy was better than you knew yourself ! (to borrow a phrase and adapt it)

          5. Matt A. Myers

            Narrowing to me is neutral, side-effect is yes – focused and therefore strengthened. :)Be a streetlight when you’re trying to see the landscape, be a laser when you’re trying to reach a specific destination/target.

          6. JLM

            .Eat your peas.You always start with a broad view, find your target and focus on it.While broad, you may not be aligned.When you are focused, you are aligned behind a clear Vision, Mission, etc.JLMwww.themusingsofthebigredca…

      2. Joe Cardillo

        Re: idea vs. execution, worth saying that there is a distinct difference between “getting X traction which we can study to see if it correlates to Y future” and “X market is huge and ripe for the taking.” The latter very rarely matters unless you have massive amounts of money and connects to throw at it. And you still might be wrong.

        1. Matt A. Myers

          True, however by observation you can see what people are already doing and then present new, hopefully better, solutions. If you can see yourself using it then it’s at least one proof point, out of many, that you need.

          1. Joe Cardillo

            Maybe, but it’s a very small starting point that then requires good customer dev to see if it’s worth doing any work on it. On the other side of the coin, making sure an investor can see themselves using it is often critical.

    2. fredwilson

      You do that so well LIAD. When you kick off a thread its almost always great

      1. LIAD

        thanks Fred. downside is it invariably means butting heads with you.

    3. ShanaC

      Why not aim for some optimism in your 40s

    4. JamesHRH

      Benedict Evans – mobile is 10X the internet. Maybe the math works.

  4. Matt Kruza

    Fred, could one of the factors simply be too much money in VCs? Both in traditional ones (which are raising much larger funds, you guys being one exception). And non-traditional firms (the fidelitys, goldman and other non-traditional non-VC money) have billions pouring in. While there are more startups, I would offer that the supply of money has grown more, so even if the “deal doesn’t work totally on numbers” as you say, they still have to invest so they can keep their job 🙂

    1. Bob Vance

      VC isn’t actually that large of a sector, it was only* $48bn last year.*That’s comparatively small.

      1. Matt Kruza

        Correct, I know the stats pretty well. But the GROWTH in VC is huge. Mid 2000’s investment was in the $20 some billions.. almost double to $48 billion. So by that measure there is a ton of capital flooding into the VC stage

        1. Seb

          The mid-2000s aren’t really a great comparison. That was the nuclear winter of tech investments – anything but a doubling in capital since then would be a huge surprise.

          1. Matt Kruza

            Hmm not sure about that. Mid 2000’s were not that far below early 1990’s I don’t hink. I think the issue is: big bubble in 1998-2001.. and then another big bubble 2011-201?? .. whenever it ends. Different factors, because today SOME tech companies have real earnings vs very few back in 1999 but I think the mid 2000’s is probably about where healthy funding levels should be, especially since cost to start a company has gone done (at least the technology component of it)

          2. Seb

            You can’t compare the early 1990s with the mid 2000s and then talk about a bubble. The late 1990s were the bubble years – and that time had considerably higher levels of VC funding:http://www.businessinsider….

          3. Matt Kruza

            That chart doesn’t include 2014 or first half of 2015, so we are up to $15-20B (particularly when greater angel money is counted). So still less than 1999, but probably double the early 2000’s and 5x early – mid 1990’s

        2. JLM

          .A prudent caution is that today there is huge segregation amongst the “types” of money in VC.Where once it was fairly homogeneous, now it is quite focused and specific.The emergence of “syndicated or organized” angels which act, for all intents and purposes, as VC firms, are not cataloged as well as they might be.The lines are a little blurry when making comparisons over a decade. There is more money but not necessarily more in the same slots as before.JLMwww.themusingsofthebigredca…

    2. Matt Zagaja

      Would be interesting to see total VC money invested versus the number of invested companies broken down by year.

      1. Matt Kruza

        Will have to find the best charts. I have seen many. Don’t have the time right now but will look. Two sources is where I will start (or you can if you want). PWC does an annual report (I think with the NVCA?) and I think mattermark has done some good charts too

    3. Richard

      The equity of startups share qualities of out of the money call options. The Volatility of startups is what justifies the option price. The demand for volatity is what drives the valuation.

      1. pointsnfigures

        How can I short premium? ; )

        1. Richard

          Short San Francisco real estate!

          1. pointsnfigures

            How do we do that? In 2006, I saw the real estate bubble and had zero idea of how to short it-turns out there was an OTC way.

          2. Matt Kruza

            Totally agree. I would short the shit out of SF real estate. Problem is its not really possible. That is part of what leads to the bubble in real estate and in startups is you can’t short them and PROFIT. I mean, all you can really do is avoid investing, which is NOT the same thing. I can’t think of any good way to short these asset classes, can you?

          3. PhilipSugar

            Was there??? I called up friends at Morgan and KKR and nobody could tell me how to short. I sold a house in 2006 and the terms of the mortgage literally made me so sick I asked to get up from the closing table.She was a single Mom and I thought she had a big downpayment. She took out a 110% LTV mortgage on a way overpriced house and commented she was going to use the money to pay down some credit card debt. The terms and fees insured she would indeed default in two years (which she did)

          4. pointsnfigures

            Yup, you had to short credit default swaps, and then let the orgs that you shorted against mark the price for 2-3 yrs while you fed it with money and took the pain.

          5. LE

            I am in the process of buying a small commercial property right now for cash. However at the price that I am buying it I want the purchase price to be higher than it is (by roughly 10%) and I want cash back at closing despite the fact that I am paying cash for the property. Interestingly I googled how to write the agreement of sale for that and found out that everything written refers to the situation you are describing as far as screwing mortgage companies.So here is a quick quiz for anyone interested. Why, if I am paying cash, do I want the purchase price to be higher with cash back? (Hint: It has nothing to do with wanting to finance it in the future as a reason to get the value increased).As far as the single mom story (has nothing to do with my quiz question) had housing prices continue to rise the story would have been told differently as is always the case.

          6. JLM

            You intend to burn it down for the insurance. Called Jewish Lightening by the goy.

          7. LE

            Nope. But actually an interesting story about title insurance.Way back bought a property at a bargain price. So the title insurance was only for the purchase price which was for cash. Well years later there was actually a title claim! Went back to the title company and said “can I get more title insurance?” and they said “sure” and they wrote another policy. Which ended up covering the claim fully. If not for that would have been hit out of pocket. This was done before an actual filing when the winds indicated that an action was pending in case you were wondering why it was not caught. Lesson learned of course.On the current property in question I own other properties in the same complex. So I am not interested in those properties being devalued on a per sf basis. [1] The down side of this approach of course is weighing what will happen with property taxes in which I will pay more than I would have to. The seller will pay a nominal amount extra in transfer taxes also. However property taxes are not evaluated until a year later and I can always show that I paid less (I hypothesize) and get the assessment reduced. Now way to check this of course but seems worth the risk potentially.For example on one particular property the current company renting the property (from me) has an option to buy at $146 per sf. The property that I am buying I am getting for only $104 per sf. In the complex properties have been trading at $125 to $130 per sf so that is my target in cash back. (Pigs get fat, hogs get slaughter by the jewish butcher..)[1] And now a new dilemma. I get called by another property owner who wants to sell. I know that I can convince him that his property is worth less by showing him what I am buying another property for. However if I do that (and if I am not the buyer in the end) then he could then sell it to someone else for less which will impact me (what I am trying to avoid). Plus if I pass him as a lead to my realtor (who knows what I am buying for) then he will also let the cat out of the bag. So I actually might have to forward this lead to another broker who doesn’t know what I am buying my place for to keep up the price that a potential buyer pays.Your thoughts and comments are invited always interested in what others think.

          8. JLM

            .My advice is this — the artificial manipulation of property prices with an intent to influence value or sales is fraud.JLMwww.themusingsofthebigredca…

          9. LE

            Who exactly is the aggrieved party here then? The seller has agreed to a price. He then further agreed to cash back so that there is a higher purchase price on the property. Had he come to me and asked me to do the reverse so he could pocket money and defraud others you have a point. Or if I was intending to defraud others by using the stated value as the value (notwithstanding my improvements comment below) then it is fraud. “By using” means “look what I paid for this property” without disclosing the real transaction. Of course I could work around that as well by showing I improved the property and it’s up to them to decide if that is valid or not.There is no mortgage company involved. Cash transaction. And in fact I am not representing to anyone the value of the property for any purpose, all of the info is public information of which it is common practice for there to be various reasons why money is adjusted at settlement. And people are free to ask any questions that they want (and get answers).Also it depends on what the definition of fraud is and what actually will even happen even if there is fraud by a legal definition.Very clear that the above scenario, in order to take advantage of a lender, is fraud, not disputing that. (Well documented).Separately, I intend to take the “cash back” and improve the property so in theory I could just as easily say “I will pay you $x but you need to invest $y prior to closing in the property”.

          10. JLM

            .Tell me again why you are doing this?What benefit accrues to you that would be absent if you did not use the real numbers?The tax “basis” for a property has to be the actual cost. It cannot be some other fictitious number.When you sell the property at a gain at some future time, the tax basis has to be what you actually paid for it.I have never seen a business which gave me confidence upon learning it has more than one set of books.Misrepresenting facts, in any context, is fraud. Whether damages are created depends upon the facts and the nature of the fraud.JLMwww.themusingsofthebigredca…

          11. LE

            From my comment above I repeat:I own other properties in the same complex. So I am not interested in those properties being devalued on a per sf basis.So my concern is not tax “basis” that has nothing to do with why I would do this.I have never seen a business which gave me confidence upon learning it has more than one set of books.Where are there two sets of books here? That doesn’t apply in this case. At all. Further any money transacted will show up on the settlement sheet at the closing. Totally transparent (for anyone with access to the closing sheet that is…)You are throwing a general “where there is smoke there is fire” even in spite of the fact that I am clearly stating why I am doing. Misrepresenting facts, in any context, is fraud. What facts are being misrepresented here? And who is the party that they are being misrepresented to? The county and town get more tax revenue by this transaction structure. Not less.The entity involved is not a public company. The principle “me” doesn’t report to, or work for, anyone. I can essentially do whatever I want. Fraud would be if there were other parties and I structured the transaction to take advantage of them.I get the impression that you have a hard time wrapping your head around the nuance of this transaction even given what I have stated is that I hope to achieve. I may be wrong in what I am trying to do but not for the reason you are stating.Separately, for any others still reading, here is a legal definition of fraud that I pulled up (the word you are kicking around)Fraud must be proved by showing that the defendant’s actions involved five separate elements: (1) a false statement of a material fact,(2) knowledge on the part of the defendant that the statement is untrue, (3) intent on the part of the defendant to deceive the alleged victim, (4) justifiable reliance by the alleged victim on the statement, and (5) injury to the alleged victim as a result.So, once again, who is the “victim” in this transaction in a cash transaction where everything is documented on the settlement sheet at closing?

          12. JLM

            .What you have enumerated is the elements of proof to support a tort of fraud. These are set and must be proven at trial.Fraud as a general category of dishonesty is simply — “dishonesty calculated for advantage”. Whether it rises to the level of a tort depends upon what facts can be proven or otherwise introduced into evidence.A tort may be based upon a past action wherein the victim and the nature of the fraud was marinated for years before all of the elements materialized or crystallized.I would caution you that settlement statements (such as HUD forms) are governed by very intense Federal law and cannot be altered at the whim of a buyer or seller.It is a crime to make a false statement on a settlement statement and folks have gone to jail for misrepresenting profit interests as second mortgages.They have exact same arithmetic result but the tax results may be different — the repayment of a mortgage does not create profit and thus tax liability while the disposition of a profit interest is always taxable.I would also caution you that if local taxes or transfer fees are in any way found to be inaccurate — though overpaying is an outlier case indeed — this can be a false official statement.Why do you want to do this in the first place?It seems a little dicey to me.JLMwww.themusingsofthebigredca…

          13. LE

            this can be a false official statement.It would be a stretch to think that a transaction of this dollar amount, even with a false statement, would end up being something that a party whether private or public or government would take up. On a large scale of course anything is possible. But this is not a large enough transaction for anyone to actually care (and that assumes by strict definition something could be done). Look when the pot is big enough anything is possible. (They guys who sued Facebook for example).Is it dicey? Maybe. But so are many things that people do or take chances doing. In business or in life. There is always going to be a balance between taking no risks “boy in a bubble” and understanding the risk (and downside) that you are taking (if any). If I was a politician would I do this? No because I can see how people would potentially view it. (Same reason I wouldn’t have dinner with a single young beautiful woman..)I had a recent case where I was discussing something with the accountant and he asked me a question. I knew by the question what the “right” answer was, it was very apparent. Had to do with money in escrow or trust and whether I would have access to the money (the idea being to try and defer income until 2016). I could have easily answered the question correctly and looked the other way and most likely and almost certainly everything would be fine. But I didn’t do that and I would never do that. Not even a question in my mind. Different details, different circumstances and so on.By the way when I sold my first business the buyers thought I was surely taking cash out of the business. The more I told them I didn’t do that the more they thought I did. I told them I occasionally would take $50 here and there (was true) but never more than that. They didn’t believe me. The reason I didn’t take money was because I wanted the sales to be legit so that I could sell the business for more!!! So whatever the sales were they thought they must be x% higher and they paid that in a multiple.

          14. ShanaC


    4. PhilipSugar

      I agree what people forget is that a small imbalance causes huge effects. For hypothetical instance if you have 10 total deals in the market and there are 11 VC’s that need to get a deal done, one will lose out and VC FOM will cause a huge increase in price. If you have only 9 VC’s that need to get a deal done the price will go down dramatically as Company FOM one knows that it will not get funded. Now this is a very simplistic example but you see it happen all of the time and people forget that the underlying condition did not change.

      1. Matt Kruza

        Agree 100%. Very similar to real estate prices, and even oil prices. Where oil demand of 2% shift (from say 90 – 92 million barrels per day) is difference from $50 oil to $150 oil. I think this is one area that traditional econmcs is particularly bad at… pricing at the margins and extreme swings. Also, add in leverage (derivatives and such) and this is amplified to where the finance / speculatin / gambling drives the habit of the actual “real economy”.

    5. LE

      Anchoring and/or contrast principle and or auction theories also at work. Once someone agrees to pay $x then paying $x plus more seems to be an ok idea.

  5. Ben Kinnard

    I imagine that the math doesn’t work because of the risk discount rather than people dreaming too big – they think the opportunity is far more certain than it is – is that a fair assessment of the current situation?

    1. Matt Kruza

      yep. Question is are they irrational in the risk discount, or are “traditional” VCs just expecting too high of returns. I think it is some of both.

      1. Ben Kinnard

        As I said, I think its the risk discount that is too low, not the return expectations. But, all the downside protections might make the lower risk value justified?(But then again, liquidation preferences are nothing new, so there is no “this time is different” with regards to that)

        1. Matt Kruza

          Well the downside protections combined with lower return expectations. THink of when institutional investors like Fidelity invest. They now have downside protection in $1 billion unicorn, and all they really need is a 2x of their money in five years. Whereas even a “late / growth” VC is hoping for 5x or more right? 2x in five years is a discount rate of 14% vs 40% for the 5x. Considering that risk free rate is 2% (on 10 year) then the institutional investors might not be so crazy

  6. Bob Vance

    If you have a successful investment, say Twitter, and as the round sizes increase can the early investors participate in every round (granted the amount contributed will not be as relatively large)?

    1. Matt Kruza

      if you have “pro-rata” rights, which usually a firm live USV would be smart enough / have enough power to include. Fred has talked about this a lot and alludes to what he takes about the “Opportunity Fund”. This where they go raise say $100 million to put into a twitter type investment from LP (investors) but they take much lower fees than the typical 2 and 20

  7. Jan Schultink

    If you read carefully on the 1st page, you might spot my name on this McKinsey article on valuing dot coms (I crunched the numbers as a business analyst)Publication: March 2000It is interesting to look back 15 years. Was it the tipping point?http://spears.okstate.edu/h

  8. Twain Twain

    Valuation is part art and part science. The science tells us to go measure the KPIs (ARPU, conversion ratios, peer comparables etc).The art tells us a line drawn by Picasso is worth more than a line drawn by Mondrian.We can’t account (yet) for people’s tastes and perceptions towards a startup any more than we can account for individual tastes and perceptions in art.We can’t measure and constrain people’s imaginations by probability in the Excel cells when we’re calculating likely value outcomes either.That’s the beauty of our natural intelligence.

  9. David Semeria

    Which tells me that many people aren’t doing this work.Or perhaps they are doing the math and invest anyway — which would be very bad news. Because that’s how bubbles form.

    1. Matt Kruza

      Well other part there is perhaps they are doing the math with a lower discount rate. Fred talks about using 10x or 5x or 3x discount. I would assume traditionally he would have used a 10x lets say. If that is down to 3x… then valuation would face nearly a 3x increase, which probably generally is true. Where a seed may have been at 2-4 million.. now at 6-12 million.. And even moreso at later stage deals some may be happy with a 2x especially when they have downside protection (liquidation prefernces). Which ironically is exactly what is causing the “paper unicorn”. There is some “irrational exuberance” but also returns expectations are going down a lot I think

      1. David Semeria

        Doing the math with a lower than normal discount rate boils down to essentially the same thing: a bigger appetite for risk.

        1. pointsnfigures

          Clearly, that’s what has been going on since QE1. Risk/reward valuations are totally out of whack. Intent of the Fed policy. Economy really not in growth mode yet.

          1. David Semeria

            Yes, if we consider you need to pay Swiss banks to hold your cash, it’s clear we’re in very strange times….

        2. Matt Kruza

          Not necessarily. I mean depends how you define risk (not meaning to be too semantical here). The corollary is that “real rate of return” vs. “nominal”. 20 years ago you could get 6-8% in govt. bonds, not you are at 1-3% on govt. bonds. That 5% decrease can cause HUGE valuation differences. Just going from a 10% discount to 5% rate doubles the valuation. That is partly what I was trying to get across.

          1. Girish Mehta

            This is not about forecasting specific interest rates (a future number and a future date in the same sentence is a fool’s errand :-)) but it is sensitive to one’s viewpoint on what is a ‘normal’ interest rate projecting ahead.As you rightly point out, the valuation “answer” is very dramatically sensitive to the discount rate used. At the same time, David’s point is right – using a lower than normal discount rate is essentially another way of having bigger appetite for risk. The question is – what is the ‘less than normal’ for rates going forward.Relevant to the point you were making – This article states that the sum of PE multiple and inflation tends to 21. At current inflation of about zero, and lagging PE multiple of about 17.5 on the S&P, its a little below that. See this chart….http://www.ritholtz.com/blohttp://www.ritholtz.com/blo

          2. Matt Kruza

            Interesting chart. Ritholtz puts out a lot of good blog posts. Appreciate the sharing. Chart porn is a risk when over-analyzing anything, but an r squared of .54 is pretty high. Its obviously not a “law of the universe” but is indeed an interesting rule of thumb.

          3. Girish Mehta

            Hmm…my sense is that markets are so distorted for the past few years that a rule of thumb based on historical data doesn’t make sense today. But, historically, seems like an interesting relationship. Thanks.

          4. Girish Mehta

            Matt, related to this discussion a few days back, there’s a subsequent post by Aswath Damodaran on why low interest rates and large cash balances skew PE ratios. Talks to the point that rules of thumb may not apply in strange times.http://aswathdamodaran.blog

          5. ShanaC

            Basically this is a what you can buy problem because money was never fully real in the first place

  10. JimHirshfield

    “Because often the math doesn’t work. Which tells me that many people aren’t doing this work.”Reading between the lines, I think you’re saying valuations are way over inflated and hence we’re in a frothy and dangerous market, yes?

    1. Twain Twain

      Or maybe that Twitter is undervalued and, therefore, a potential acquisition for Google:* http://uk.businessinsider.c

      1. pointsnfigures

        Twitter could be undervalued. But at this point the math has a lot of private equity math in the valuation along with some venture math about what it could be under the Google umbrella. That’s how Facebook has paid what others see as sky high valuations for Instagram, What’s App, Oculus.

    2. Richard

      Dangerous to whom? Worse case scenario, probably only VCs! startups have become an asset class and a small one at that.

      1. JimHirshfield

        I wasn’t referring to am entire asset class or the economy in total. If you raised your last round at a $1B valuation and then…pop goes the weasel…you now are having trouble raising money at a $750M valuation, then I say, “Danger Will Robinson, danger”http://memecrunch.com/meme/…

        1. Girish Mehta

          Absolutely. And startup employees and founders might carry greater risk than investors. As Heidi Rozen says here – “In all but the most glorious outcomes, terms will matter way more than valuation”..http://heidiroizen.tumblr.chttp://techcrunch.com/2015/

          1. JimHirshfield


      2. John Rhoads

        And the LPsAnd some public participants via equity crowd funding

  11. Tom Labus

    I have found in the public markets that on the edges of both buy and sell are investors with conviction of their analysis and a huge range of investors in between following for whatever reasons, including not wanting to do the work. But conviction is alwys in short supplyThis is a great post, Thanks

    1. pointsnfigures

      especially when you need to get out!

  12. pointsnfigures

    One of the problems is businesses aren’t what they seem sometimes at the beginning. This is especially true at a seed level when you invest at early product market fit. Might not be the real product market fit and when the business changes stride and finds the real vein of ore it can tap it becomes huge.At seed, it does no good discounting because the outcome is binary. Either it hits, or it fails.

    1. awaldstein

      As s seed investor where in almost no cases is there market fit nor a model, what are you using for decision criteria on choice and valuation other than gut.

      1. pointsnfigures

        I think you can use all of the things Fred wrote about. Often, you have to look at different ways to use the business. What do you know than no one else knows? How can you create a decision that has asymmetrical information?At seed, the valuation is different. It’s important to have some filters, like sector or target markets. You can engage in discipline around what valuations you invest in. For example, if the company wants a pre-money valuation over $5M at seed, I have a pretty hard time getting interested given the risk. I HATE consumer products. Lost 100% of the time with them. If a company has a B2B component that involves consumers it’s a bit different. Other people are different. I know people that ONLY invest in consumer because they are so comfortable with it and have a track record of success.Business models can change so much in seed too. The initial hypothesis that you make might not turn out-but as Fred has pointed out several times on this blog, a good operator can take the business, change stride (It’s often not a true pivot) and make a business out of it. But that pivot changes all the initial metrics of lifetime customer value etc.When you get past the seed round, Fred’s metrics around discounting the exit come in big time. I do think about the exit, but only in a macro sense-like who could acquire this company since they are not likely to do an IPO.

        1. awaldstein

          Nicely said.I’m not a seed investor by vocation but I raise a lot of seed for clients and I can tell you that the criterial for investing is all over the place, more emotional than anything else.

          1. pointsnfigures

            I think there is always gut feel and emotion when investing, and when trading. How you deal with it can be the difference between success and failure.

          2. Dasher

            The most common criterion is FOMO – someone they know invested so they will. That is the emotional part.

          3. JamesHRH

            Can we connect in the next little bit? My contact info is on my personal site – http://www.jameshrh.com

        2. James Ferguson @kWIQly

          To scale B2C must to find something of some value that many people want.Video-game, Social MediaB2B needs to offer something of precise value that nobody has.Enterprise Software, Airplane ManufacturerOn the age front B2B requires experience because resolution of the search is much finer so understanding of need must be far greater (even a niche differential will do in some cases).I think this makes B2B more about P/M Fit

      2. JLM

        .Jockey, horse, course.Never saw a good horse make it through a tough course with a bad jockey.You’re almost always betting on the jockey.JLMwww.themusingsofthebigredca…

        1. Richard

          A great horse makes a good jockey. What is scarcer great horses or good jockeys?

          1. Matt A. Myers

            Or at least can have a better chance getting them to the finish line.

          2. Richard

            It’s easy for a VC to go to his LPs and justify his bad investments on the market wasn’t ready, poor market fit etc., really hard to justify an inept founder.

          3. JLM

            .The rate of failure of VC investments — particularly seed stage — is staggering.It is the founder who is holding up the lens to the market, the timing, etc.JLMwww.themusingsofthebigredca…

          4. panterosa,

            the jockey imagines through the lens.

          5. JLM

            .Spoken like a truly brilliant jockey and creative person. But then you already knew that, didn’t you?JLMwww.themusingsofthebigredca…

          6. panterosa,

            Let’s hope you are right!

          7. Richard

            Do you really think the founders of grubhub / seamless / instacart etc. had any special lens?

          8. JLM

            .They had a vision — vision is what you see on the other side of the lens. They absolutely had vision.Most importantly, they acted on their vision and converted it into a mission, etc.JLMwww.themusingsofthebigredca…

          9. panterosa,

            So as the metaphorist who needs a diagram to explain things, I would say the lens is the question – the what if?

          10. Richard

            total agreement on that one, but there are 1000’s of great pizza shops where great people execute everyday.

          11. JLM

            .Great pizza jockeys all and I want to eat at all of them.BBQ, TexMex, pizza — the pillars of civilization.JLMwww.themusingsofthebigredca…

          12. James Ferguson @kWIQly

            I can eat like a boss – but I guess not what you mean 😉

          13. Matt A. Myers

            An idea or company being started is most usually just a “remix” of other ideas someone has seen/heard. To see a market opportunity and be able to act on it you only need at minimum to execute better and with a slight differentiation that adds value to whomever you’re creating for – and the ability to have the resources, your own or to raise it, to build your vision – or ability to do it yourself.

          14. James Ferguson @kWIQly

            And a better chance of knowing which way it is to the finish line

          15. JLM

            .At the seed stage, the horse is still a colt and you may not be able to get a saddle on him yet.JLMwww.themusingsofthebigredca…

          16. JLM

            .In the real world of racing, that is not true. May not be the point of your comment.A great horse is developed by a great trainer.The trainer puts the right jockey on the saddle and in the horse’s head. It is the jockey in the horse’s head that makes them a winning combo.The jockey knows the tactics of the race given the competition and the conditions — then, he tells the horse the moment at which to bring forth his greatness.Jockeys talk all the time about holding back a great horse until the field is set before him and then finding the crease and turning the horse loose.When the jockey turns the horse loose, he may whip the shit out of him knowing that the horse has even more than the horse thinks he has and the jockey is going to make him deliver it for that half a minute.He is not looking for the horse’s average great performance, he is plumbing for his all time best — the reason why they keep record books and why great horses are in them.The jockey knows the horse doesn’t have to be great from starting gate to finish, he just has to be great at the decisive part of the race.I was a hot horse walker at Monmouth Park in NJ a few summers and I found jockeys to be smart as hell when it came to knowing how to get a performance out of a nag.There was one jockey who said the most important part of his equipment was his whip. He could whip a mediocre horse into the winner’s circle. He was perceived as a mean SOB but he knew his craft.JLMwww.themusingsofthebigredca…

          17. Richard

            during highschool, I spent some time in the paddocks of a number of race tracks, a great jockey could do only so much with a mediocore horse, a jockey adds +/- 10% to the ride,

          18. JLM

            .In a business in which they have a camera at the finish line because they need a pic to determine a winner — isn’t 10% a Hell of a lot?JLMwww.themusingsofthebigredca…

        2. LE

          I don’t know if I agree with the horse analogy (but keep in mind that I know nothing about horse racing or horses).(So here is the other side of this..)The reason is this. My theory on business is that it is simply taking advantage of the low hanging fruit of opportunity. So there is more of a chance that a mediocre person can pull off the low hanging fruit of opportunity than a best and brightest can pull off a business that is not low hanging fruit. I am not talking about the outliers but the non outliers.Let’s say, for example, you take an average smart guy (of which there are thousands just like him (or her)) and they open a pizza shop in a good location. In the end unless they are total fuckups if they are located in grand central station they will pull that off and figure it out. On the other hand the best operator in the world won’t make a fortune in a poorly located strip mall next to dental office (you know bad strip malls have non retail tenants and all of that). (Not that part of being the best and the brightest wouldn’t be figuring out a good location of course..)This doesn’t mean that there aren’t people that are better at business than others are. Of course that is the case. But in many cases when you have a good idea and/or an idea where there is a demand a smart person will figure it out and go along for the ride.

          1. JLM

            .I think we are talking about two dramatically different types of businesses. There are not too many VC funded pizza joints.As to your example, even the pizza guy can become a big success by being a good jockey.Pizza joints existed for a long time before someone built them into a chain. Went big.Who drove that effort?The jockey. The pizza jockey.JLMwww.themusingsofthebigredca…

          2. LE

            It’s my “PSA”. That is an attempt to provide a different perspective and balance on this blog. Young people should be attempting to not hit it out of the park and gamble but perhaps get involved first in a traditional business idea. The way it looks in this day and age they only know or seem to care about one thing. Being the next Zuck.Who drove that effort?Well if we take as an example McDonalds Kroc who was “just a salesman” in his mid 50’s took advantage of the low hanging fruit of opportunity that he recognized from his travels and coming in contact with the McDonald’s brothers.Likewise the GoPro guy. This doesn’t mean they weren’t better than someone else in being able to take advantage of that opportunity but the fact is w/o that low hanging fruit nothing would have ever happened.

          3. JLM

            .I think you make the argument that it is more often the jockey who makes it happen.There was a McDonald’s before Ray Kroc and then there was a McDonald’s after Ray Kroc.In fact, he did not invent McDonald’s. He rode someone else’s pony farther than they could imagine it could be ridden.Ray Kroc = jockey.JLMwww.themusingsofthebigredca…

          4. LE

            Well ask yourself this question then. What if instead of doing real estate in Texas you had been a jockey in NYC real estate? All else equal do you really feel that the people who run the Durst Organization are really that much smarter or better operators than someone doing the same thing who is located in, say, Austin Texas or Philadelphia (where there is no bedrock and the Billy Penn building height limit)? By “metric” I mean “riches and big important buildings” not quality of construction and so on. Point being you can’t get blood from a stone there has to be the opportunity as well to exploit.

          5. John Rhoads

            Sometimes you can pick a market, but you usually can’t pick your timing

          6. JLM

            .It is jockey, horse, course with the “course” being the market.The market matters but only if you have a good jockey to get the horse out on the course.I was in NYC before I moved to ATX. I moved there because there was no established industry infrastructure and a guy with not a pot to piss into could get a start.It was perfect for me and I knew what I was doing. At one instant in time, I was likely the only guy in the ATX — at that instant in time — who had actually built a high rise building.A few years later when all the Dallas guys and Houston guys showed up, no longer true but by then I had made my bones and I could whip them like a rented mule (not really but I wasn’t afraid of them and I had political connections that they didn’t have — it’s always good to be local).JLMwww.themusingsofthebigredca…

      3. Matt A. Myers

        What if you have market fit and a model – you don’t go out and raise a Series A amount?

        1. awaldstein

          market fit is a relative quotient. trust me it changes and evolves.all companies are either worrying about market proof or about loosing the market they have.

      4. LE

        “As a seed investor” – well in these types of businesses that is.There are a slew of businesses that people could invest in where there is market fit and a model however they don’t fit the gambling model [1] that appears to be common in the startup world. So they don’t trigger the greed reflex or whatever you want to call it and of course there aren’t blogs or incubators dedicated to hyping those types of investments. At least none that I know of.My question is when is gut based on the halo of the particular founders [2] vs. the actual businesses they are trying to start?[1] This is not intended to be pejorative. People can and do earn a living by being good gamblers.[2] Based on age, education as opposed to actual operational experience.

        1. awaldstein

          Nicely said.To be clear, low multiple but solid businesses still require a lot of capital to get started and scale.Few become Shake Shack. More return profit and dividends consistently for a generation.

          1. Otis Funkmeyer

            this seems to be the most underappreciated path towards wealth, happiness, and quality of life in 2015. the good part is their overlooking is our opportunity 🙂

          2. LE

            Few become Shake ShackHat’s off to Danny for great execution, marketing and PR but at it’s core Shake Shack is just another unhealthy sugar and fat delivery system, despite messages like this on the website:100% all-natural Angus beef, vegetarian fed, humanely raised and source verified. No hormones or antibiotics – EVER. We pride ourselves on sourcing incredible ingredients from like-minded artisanal producers.In small doses and when eaten by people with discipline not a problem. However in a culture where people have associated food with pleasure and it becomes an addiction that leads to obesity and unhealthy lifestyle is an issue. Of course if it were my business idea I’d be the first one to rationalize and do it as well.Starbucks essentially the same thing. Not a coffee house but a sugar and fat delivery system with a social component.

          3. awaldstein

            no question especially as from me as a health bigot for certain.i’m very interested in this category of business.next read is this that you might enjoy.http://www.amazon.com/Small

          4. LE

            Wow Bo Burlingham. As someone who went through the 80’s and the golden age of Inc Magazine (made the Inc 500 in 1988) [1] sounds like good reading. That magazine used to be the place to go for inspiration (haven’t touched in in over 30 years..)[1] Was a faux big deal back then and milked it for all it was worth.

    2. Richard

      There are other exits?

  13. William Mougayar

    Are you saying that seed stage investors aren’t doing this work by investing in situations that aren’t making sense, or that the private market valuations are so high and irrational that it will be hard to find the ROI at the end of the tunnel?

  14. Jeff Robinson

    And last but not least, no idea that Google would end up buying Twitter in 2015.

    1. Matt A. Myers

      It could happen. It would probably be bad for Twitter ecosystem, however would keep Google relevant for awhile longer.

      1. JamesHRH

        If you have a laptop and a browser, Google will be relevant Matt.

        1. Matt A. Myers

          Am I missing something? Did Google acquire Twitter? I don’t see anything really popping up in searches..

  15. Dave McDougall

    Change one assumption in the model and you’d get a different answer. Pitch 100 VCs, but if only 1 or 2 say ‘Yes’ you can raise a round.If every investor does this work, it’s the few outlier VCs that make a borderline company fundable, despite the near-consensus — which seems to me like a good thing.

  16. PhilipSugar

    You use the word imagine six times in this post, if you are having a hard time with valuations after all of that imagination that really says something.There are people like me that have a hard time imagining the super optimistic case because as LIAD’s quote says as we get older we’ve seen that not work out so well.

    1. LE

      Perhaps a better word is rationalization rather than imagination. In the end it really just boils down to spreading the risk around on multiple investments with the hope that you are right on a few of them. I don’t believe that anybody has ever disputed that.

      1. PhilipSugar

        No, I think the word imagination is correct.You have to be able to imagine the dream to get to anywhere near the valuations I have seen him reportedly give.This is one of those times both of us can be right. Fred does well with his imagination, I do well with my strategy of hitting singles and doubles, we both score plenty of runs.You are correct that the home run strategy only works well if you get plenty of swings.But when Fred says he can’t make an investment, that truly says something to me.

        1. LE

          You have to be able to imagine the dream to get to anywhere near the valuations I have seen him reportedly give.Probably a big advantage to being able to dream is not having any actual operational experience to see what can and actually does go wrong in a business.I am reminded of a guy that inherited his father’s catering business. One night, at an affair that his company was catering, he sat there totally relaxed and not worried at all (he was also an invited guest). Amazed, I asked him how he could do that. He told me something like “well you just have to trust your bellman!” (or whatever he called the black guy who had been with his father for 40 years that ran the show).Anyway I was absolutely stunned at how he could sit there and not worry at all. But the fact is he had inherited the business and by the time he got it many of the kinks had been worked out and they had a stable of good venues where they were 1 of 3 catering choices (synagogues for kosher catering).However I don’t think he really knew, since he hadn’t built up that business from scratch, how close each time he came to losing a big account (or clients) if an affair got fucked up. Say that “bellman” got sick or equipment broke or labor became discontented. So he didn’t know what he didn’t know. That is why he could sit there and not worry. Not because he had built a well oiled machine but because he wasn’t around long enough to see what can happen.When I owned a printing business I know exactly how much effort went into landing a big account. And I was always up at night worrying about losing that account because I knew what could and did go wrong. Fifty things had to happen correctly for a job to be delivered on time and for that account to not try another vendor if they didn’t get what they wanted. Which would mean starting from square one and trying to land another good account. Once I sold that business none of that mattered anymore. It wasn’t my problem if a pressman didn’t show up or if a truck broke down. The loan was secured by collateral and personal assets the day to day no longer mattered.

        2. ShanaC

          but yeah, numbers game, how do you want to make this work – I feel like there is a moneyball strategy somewhere in between you both

          1. PhilipSugar

            Very good comment.I have noodled this for a very long time. I don’t have the answer.You are right there should be some in between where slowly building a $10-20mm business versus a $1B “unicorn” (I really hate that term) works.The math is really tough. Its kind of like owning a couple of restaurants versus building a chain, or the chasm a company goes through when they go from 20 employees to 100 employees to 1,000 employees (substitute revenue)Problem: It is hard to justify (pay) for the overhead. When it is your money, you just say this is what I am going to do and I am responsible for the results. When it is OPM you need not only to pay them their money, realize the fact that losing hurts less and therefore happens more, but pay yourself as well and you are now dependent on others.PS Moneyball is a nice story but it should also include BALCOhttp://www.huffingtonpost.c… http://www.slate.com/articl

          2. Joe Cardillo

            It’s an interesting question. I talked to a fairly known VC about this last fall, and he openly admitted that many VCs (himself included) don’t like that it’s a $0 or $1bil return. I don’t have enough experience w/venture capital to say if that’s just the way it’s played, but that middle ground seems highly inefficient (is an opportunity?).

          3. Matt Kruza

            It wasn’t the way it used to be, but I think it basically is when you start to have $250 million plus funds, and it 100% is when you raise Billion funds. In the long-term I think that venture funds will start to come back to smaller amounts (50-200 million). This won’t happen for a long time (10-15 years probably) but I think a ton of the ttrend is the “efficient market” here. You can exploit inefficiencies at a small scale, but when you start talking about billion plus companies (let alone 10-50 billion private companies) you can’t justify the fees that VCs take (4-6% fully loaded between management fee and carry) and create wins

          4. Joe Cardillo

            That makes sense. It’s a bummer, lot of capital inefficiency til then. Suggests founders need to think long and hard about if they’re good with a medium or slow, and more sustainable growth track. I’m sure that plays into part of why a lot of venture money goes to under 30 set, w/experience and years under your belt once you’ve built something people want it’s harder to justify destroying because it caps at tens or hundreds of millions.

          5. PhilipSugar

            You don’t hear the stories of those that build those kind of businesses. We fly under the radar.

          6. JamesHRH

            Benedict Evans would argue that its the nature of mobile: it costs nothing to build or operate (comparatively), its incredibly crowded and the value of a win is 10X the win of a PC based, traditional internet win.Its actually more like 0 or a $100B.Of the over $100B club, there is only Google & FB.Which is more inherently valuable?Google, both historically (YP were quietly the most valuable media properties pre-internet) & intrinsically (search is a broader & deeper resource than any online media property).Yet, the last time I checked, Google was only 1.5x FB. Would that have anything to do with FB’s aggressive and successful move into mobile?

          7. Joe Cardillo

            Don’t you think that’s temporary though, winning in mobile? I guess 5 or 10 years dominance is enough to buy time to figure out the next thing, but I admit I rather like the Elon Musk longer view of things.

          8. JamesHRH

            From the FB PoV, its move into mobile or die. So……Any ad based media property has a shelf life. I think FB’s is pretty long.The Google of Mobile is likely 10X FB, which is why this is so true and yet, so funny – sorry, can only view on YT. https://www.youtube.com/wat….

          9. PhilipSugar

            See my long post, now that the thread is closed.

          10. ShanaC

            I use it metaphorically. I don’t like baseball. But it seems we’re all off somewhere,misreading a metric or something

          11. PhilipSugar

            See my long post. Above.

          12. awaldstein

            Great comment.You and I both have a soft soft towards building these types of businesses.I find though that the idea of ‘lean’ while gutwise we all practice is not necessarily helpful as not having the capital to make smart decisions is I think a negative.

          13. PhilipSugar

            Once you have had success you have the capital. Now I know that doesn’t help people starting out.Here is actually the killer for those without capital, Hard for me to say it: The entrepreneurs:You as an entrepreneur have to be willing to give up half your business for $500k and with today’s valuation envy that just isn’t going to happen. People think a $3mm pre is a steal for an idea and the grit to work on it.But here is the math if you institutionalized:$500k to start ten businesses: $5mmOne person and an office to run for ten years: $2.5mmFollow on money: $2.5mmSo shoestring: $10mm needed. Anything lower than $20mm you are a flop $30mm in return to make people happy.Of the 10:4 are going to be zero3 are going to be able to pay you back: $1.5So the last three are going to need to net you average $6mm on the low end $10mm on the high end, that means you need to own 50% of those businesses.You can do all sorts of variations, invest smaller amounts upfront and follow on, hope more can pay you back, double your money on the ones that do etc, etc, but that is pretty much the math.Other major problems:Would I really want to do that?? No I’d rather fund my own thing and take the risk on myself not 10 people I don’t know.Would others want to put up money??? Hey put up $500k to own businesses nobody has heard of, or put it in some social startup??? or with a broker who will kiss up??No what really happens is you need an angel that loves your product.

    2. Matt A. Myers

      It takes work to keep your energies open, to not have your guard be up – to not be pessimistic or depressive about the future – as it’s easy to happen in the current state of the world today if you pay attention to the pain and suffering and horror. Yoga can help open you up deeply and give you tools to manage. 🙂

    3. JamesHRH

      Someone I know who founded an airline – I know, even I struggle to get my head around what he did and that he has coffee with me – told me that investing is about intuition.I like that word.It carries the weight of experience, lots of hard reps and the maturity to quiet your mind.I also like the concept of ‘audible clicks’ – the sensation of the tumblers of the lock coming together (for certain personality types). That’s intuition becoming certainty.

  17. Salt Shaker

    The Street continues to punish TWTR unmercifully. They’re “hell bent” on comparing key company metrics to FB, particularly MAU’s, which is not a fair comparison. They’re two distinctly different communication tools that fall within the “social” banner. Somebody is gonna come along and recognize that TWTR is undervalued, although current mgt may not be around to see that day. I did scratch my head a bit when the CFO was given oversight for TWTR marketing. Never encountered a CFO who knew squat about marketing.

    1. Joe Cardillo

      Agree. Found that very confusing. Won’t claim to know what risks Twitter should be taking / testing out, but the language Noto is using suggests he doesn’t truly understand or care about the core value of the product —> paragraph 5, scary stuff: http://www.businessinsider….

    2. John Rhoads

      Feels like a fair comparison to me. What other comps might be more suitable?

      1. Salt Shaker

        For clarity, I’m not saying TWTR metrics shouldn’t be compared to FB…they obviously should. The problem lies in the context of the comparison. There are fundamental differences in how TWTR and FB are used and by whom. There are inherently fewer ad opps w/ TWTR than there are w/ FB, LinkedIn, etc., or other microblogging sites that can deliver deeper/richer content. That doesn’t mean TWTR can’t be a great and potentially highly profitable platform. It likely will, but TWTR gets unfairly penalized by the Street cause it isn’t FB. Side-by-side metric comparisons are inherently biased. Context matters.

        1. John Rhoads

          Understandable… but I’d suggest we continue the comparative language throughout the thought: is Twitter, given its different users and revenue potentials, more valuable our less valuable than the others.This is all directionally informative thinking. The very troublesome mystery, and I think the one you are speaking to, is how much more or less valuable is it?!What better way to estimate than the collective opinion of a market? Better yet one in which you can participate and influence the opinion!

          1. Joe Cardillo

            Twain had a great comment on comparatives between the big players a couple of weeks ago that’s worth thinking about, too: https://disqus.com/home/dis

          2. John Rhoads

            Good find. I can think of this philosophy for Apple, Google, FB, but for Twitter it isn’t as clear to me.I’ve read Ev speak about Twitter being a voice for the internet. For a while it was the 2nd screen partner to traditional TV and video.Its an interesting/opportunity and problem.

          3. Joe Cardillo

            Yep I agree. I do think there is a philosophy for Twitter based on how people use the platform but I’m not convinced the exec team understands it and/or how to make it their core business.

    3. PhilipSugar

      That is why Josh Koppleman says numbers fuck up a good story. Not saying your point is right or wrong, but their numbers are going to get compared to somebody.

      1. John Rhoads

        Maybe even call them contrasts… But I agree with this point. The comps tell you about differences. It us also clear that Twitter *so far* has had quite a bit of trouble commanding ad money the way others haven’t

      2. JLM

        .”The higher you climb the totem pole, the more of the world that can see your ass.”Everyone and everything is going to be compared to somebody. Truth.JLMwww.themusingsofthebigredca…

        1. JamesHRH

          Totem pole climbers tend to have good glutes though.

    4. ShanaC

      If you buy ads the real comparison is TV. Therein lies the problem

    5. JamesHRH

      Holy smokes – link to that CFO now CMO story?That’s on the far side of unorthodox.

  18. markslater

    always be tacking right!

  19. falicon

    I’ve seen this as a long standing disconnect between investors and entrepreneurs…one often doesn’t do a good enough job imagining and the other often goes *way* too far into their imagination…it’s only once they can both meet somewhere in the middle and ground those imaginations in real-world facts and product-market fit (i.e. sales or revenue) that it seems to *actually* work out…

  20. Matt A. Myers

    This creative process that you speak of is really the only way to understand the potential of something. Just with like development, you need to brainstorm first – hundreads, if not tens of thousands of ideas or variations – and then you must prune down and prioritize those ideas, which is where execution comes from.<sarcasm>I think I picked a bad market to be passionate about and start a business in.. It’s too bad yoga has only been growing at 30% every 4 years for more than a decade now… though maybe it will help that health-wellness apps is the fastest growing category..</sarcasm>In reality the for-profit capitalist system has been putting pressure on everything and decreasing the quality of life for everyone, leading to people becoming more and more sick and in a dis-eased state, and ultimately forcing people to learn how to heal and to be healthy because of the unhealthy learning/role modelling we’d see in our environment if we’re blindly trusting it for guidance. I envision a world where all behaviour you see is role modelling a healthy way of living and interacting with others and our environment, and so the learning is inherent and natural to everyone – and I am building that philosophy into my projects.

    1. JLM

      .I applaud your optimism and I am with you on wellness but capitalism has delivered the highest quality of life in the world even if measured by life expectancy.Averages are built of the best of the worst and the worst of the best, so folks who adopt a healthy lifestyle are in those numbers. How long before the average life expectancy is 100? How long before the 10% outlier is 110?Much of society’s problems is based on how long people are living — when Social Security was designed, the average life expectancy was less than 60 for a program that didn’t kick in until 65. The house had a big advantage.Today, life expectancy is arguably 84 for a program which can kick in as early as 62. The house is screwed. Worse still, the outliers are getting older and older.JLMwww.themusingsofthebigredca…

      1. Matt A. Myers

        Indeed capitalism is working, the yin-yang balance is still in affect and now is moving into the other direction. :)To note, life expectancy shouldn’t be confused with quality of life.

        1. JLM

          .Fair play as it relates to quality of life. The truth is that both longevity and quality are improving.JLMwww.themusingsofthebigredca…

          1. Matt A. Myers

            Longevity and quality are improving for some – which is a good sign that we at least know how to do it, and now it’s to the point of scaling that for all – part of my hopes with I Live Yoga.

  21. mike

    Fred, you mentioned it in an earlier post that when the discount rate is zero … the npv is infinite. There lies the problem to a certain extent.

    1. fredwilson


      1. samstewartnz

        The infinite npv case also requires that cashflows continue in perpetuity

  22. Varun Khona

    I think the ‘discount 3-10x for the risk that none of this might happen’ has long been replaced by lets optimize (read: FOMO) for the bets that do make it happen. Story of the times we live in.

  23. Stanislas Marion

    It seems Twitter has created a lot of value for its users, but has so far failed to capture any of it. It is haemorrhaging money with no end in sight. I’m a fan and use it every day but worry about their future.

    1. fredwilson

      that is not correct. they had $92mm in operating cash flow in the first quarter of 2015. that means they produced $92mm in new cash from operations. that’s far from “hemorrhaging money with no end in sight” people keep saying this about twitter but it is not true and hasn’t been for years. it really annoys me that people can’t read financial statements and understand what is really going on

      1. mike

        TWTR probably has misleading financials from stock-based comp

  24. JLM

    .The estimation of what something can be “worth” is an exercise in developing a set of assumptions and then applying them to some form of projection of the possible outcomes given those assumptions.Not to get too numbery on you — a DCF with a bunch of different assumptions (growth rates, customer spending growth, revenue per customer, expense ratios, discount rates, time periods) is just a SWAG. Why not?It should be encouraged rather than discouraged to make multiple such projections testing the linkage and correlation among the changing variables.This results in high, medium and low plus “this dog doesn’t hunt and never will” scenarios.When you build the model, don’t abandon it. From time to time, play with it as the volatility of certain variables begins to be tempered and dampened.At the end of the day, this is exactly what the Black-Scholes model attempts to do to assess the fair market value of options. Just an example. The big assumption being volatility of the stock which is absurd in a little company which may not have an auction place for its stock.When you have a few years in the soup, it is amazing how accurate you can get at this kind of stuff.For an operating business trying to start with its revenue and a couple of years under its belt, it can become incredibly accurate. As the key input into the overall valuation, it makes it much more accurate.JLMwww.themusingsofthebigredca…

    1. Tom Labus

      There should be tools for this on secondmarket.

  25. ShanaC

    That concerns me – that people don’t sit there and think in order to chase returns. Isn’t that good money after bad Does that mean that we are nearing the end of returns for amny things, or edging towards new innovations and that the problem

    1. Matt A. Myers

      Returns to people or returns to VCs? Breakeven in reality is the best end point for everyone, e.g. at break-even then the ecosystem isn’t wasting money.

  26. Jim

    People are just seeing nice products with traction and praying they will grow and with that work out a rev model

    1. Matt A. Myers

      Logic exists which allows for accurate predictions, what’s less unpredictable is the competition and how that will impact things.

  27. John Rhoads

    “There is no greater importance in all the world like knowing you are right and that the wave of the world is wrong, yet the wave crashes upon you.”– Norman Mailer

  28. Nidhi Mevada

    Typical valuation depends on three factors,1. Product price2. Market size3. Company projectionsBut on other size when someone is putting her/his whole life on only one thing, then we should relate valuation with,1. Product’s value in user’s mind2. Including projections, they should give more focus on Vision rather then revenue streams.That’s why we call them “Angels”

  29. Michael

    I totally agree with this perspective. My Benchmark partner Bruce Dunlevie always asked “what could go right?”The funny thing in this business though is that i am not sure anyone looked at Uber and said “uber will replace buying cars” and “uber will replace rental cars.” Instead they said “It will replace all taxis and then expand that market. The lesson from this is that when you disrupt an industry very meaningfully, it is hard to know how far that disruption will carry. Uber disrupted transportation and not just taxis.When we invested in WeWork for example, should the question have been: Can WeWork disrupt temporary office space? Commercial Real Estate? Or the way people work and live in the 21st century?The different answers to that question yield massively different “imagined” or “possible” outcomes.

    1. LE

      Not a stretch to think that Uber would replace buying cars. Taxis have replaced buying cars for some. So have rental cars. Rental trucks have replace buying trucks for that matter.Can WeWork disrupt temporary office space? Commercial Real Estate? Or the way people work and live in the 21st century?What Wework appears to be selling is really community, serendipity and a fun place to work. Like a summer camp for millenials. Very nice for a certain age group of people. My question with that though is what happens if and when the bottom falls out of the type of investing that funds the target group of occupants those that are current wework tenants? There will always be survivors but perhaps not enough to make it viable without the larger group that is cash rich.

      1. LE

        Picture attached of the fun.

  30. Sriram Yadavalli

    I guess the last statement is the strongest hint that we are in bubble territory no?

  31. Andre Jacobovitz

    For those technical folks, I highly suggest reading a blog by Professor Damodaran from NYU Stern, who takes a stab at explaining the $19B Whatsapp acquisition by Facebook from a valuation perspective: http://aswathdamodaran.blog…Bottom line, he disregards traditional valuation techniques (mainly DCF) and relies instead on the number of users as the dominant valuation driver. To me, it’s very telling that when dealing with tech companies, one of the leading valuation experts basically says “forget about the math (for now), since user metrics are king”.

  32. JaredMermey

    Can you back into value at time of investment by multiplying this Future Market Value against some sort of percentage chances it will actually get there?Clearly very subject math where all the parameters are triangulated from whatever info you can ascertain about the company/space/marktet. Also, perhaps, the odds of success become so minute that multiplying that against any Future Market Value to get a Current Expected Value might lead to too small a number for any entrepreneur to accept.Would be interesting to understand how a VC might go about this when Current Expected Value less upfront capital infusion investment is negative (especially with time value of money)?

  33. george

    Great advice and the opening sentence is really a loaded statement. I find determining “potential worth” the hardest part in valuing nascent investments. I’ve had many sleepless nights trying to properly evaluate future market values based on visualizing product/business thesis.Lots of school of thought here but I’m placing a higher premium on investments whose markets are positioned in the upper right quadrant, targeting substantial marketshare and possess a management team that holds lower execution risk. As we all know, worth and value are in the eye of the beholder…

  34. Deepak Ravichandran

    Great post – I think about this issue a lot. To quantify discounting the upside, you can make a probability-based DCF – the biotech industry does this regularly, as theprobability of passing each FDA testing stage is relatively known. Witha 10% chance that a Series B company might create future cash flows worth atleast $500m, 40% chance of flows worth at least $100m, and 50% chance of flows worthat least $20m, you can arrive at a value of $100m.

  35. Dasher

    There is another layer to investors buying at high valuations. They have downside protection thorough liquidation and participation preferences. So even if the companies do not achieve the lofty valuation goals – they get their money back and some before the founders and employees. OTOH if the company hit the goals they have a huge upside. Here is a nice article on this..http://techcrunch.com/2015/

  36. Darryl D.

    I’ve always been curious to know the fuzzy math used to justify investments and valuations in some companies today. Is it a function of backing into numbers to justify deploying capital, or do VC’s truly believe that business fundamentals have changed?

  37. Vineeth Kariappa

    Did Fred Wilson state that, there IS a bubble ?

  38. Kenny Fraser

    Good post. Complex financial models to value early stage businesses don’t make sense. Investing is a statement of belief in the potential. That’s why team is so important.