News Column

Startups at $1 Billion Barrier: Now What?

Nov. 19, 2012

Nick Bilton

money and dice

Congratulations! Your startup is now valued at more than $1 billion!

This might seem exciting, as though you had won the lottery. But there is a catch.

Being in the Billion-Dollar Startup Club limits how, and whether, a company can get out of the Billion-Dollar Startup Club -- at least safely.

The club is growing quickly. Based on recent financing rounds and stories about the companies, Twitter is valued at $8.5 billion; LivingSocial at $5 billion; Dropbox, $4 billion; Square, $3.25 billion; Spotify, $3 billion; Rovio, $3 billion; Airbnb, $2.5 billion; Pinterest, $1.5 billion; Box, $1.2 billion; Gilt Groupe, $1.1 billion; and Evernote, $1 billion.

Dozens more companies are within arms' reach, including Foursquare, WordPress, GitHub, Quora and Fab.

They have a lot to worry about. First, when you are the most expensive product on the shelf, very few companies can afford to buy you. Apple, Google and maybe Microsoft are on a short list of corporations that could finance an acquisition of this size.

Given that Apple rarely makes acquisitions, that leaves Google, Microsoft and possibly Facebook.

And speaking of Facebook: after its lackluster initial public offering, when its stock dropped by half, going public is not very appealing.

Groupon, valued at $12.65 billion before its public offering at $20 a share, is now trading at a mere $2.98. Zynga, another member of the Club, is now $2.21 a share, down from a high of $15.91 this year.

"As a startup valuation increases, the options definitely decrease," said Jon Callaghan, a partner with True Ventures who has been investing since the early 1990s.

When you are valued at more than $1 billion, he said, "you have to have a flawless execution, as it's upping the ante quite a bit."

Some of these companies' valuations might be justified by revenue and growth. DropBox, for instance, has an estimated $500 million in revenue and 100 million users. Others, like Pinterest and Fab, are as overhyped as Pets.com was in Tech Bubble 1.0.

If these companies are deemed overvalued, they may have no option but to perform so-called down round investments, in which a round of private financing prices a company at a lower valuation than a previous investment.

That almost happened to Spotify, the music streaming service. In May, the company was ready to close a round of financing that would have valued it at $4 billion.

Then Facebook stumbled, and Netflix, which is the closest example of a subscription-based online service like Spotify, did so as well.

Spotify finally closed a round this month that valued it at $3 billion -- $1 billion off its projected valuation just six months ago.

"You certainly have more options at the $10 million valuation and a lot more paths you can go down," acknowledged Aaron Levie, chief executive of Box, a corporate cloud storage start-up. "But there's a virtue to having less options, in that it gives us the ability to focus, and our visibility of what we need to do is much clearer."

Start-ups with higher valuations can also run into trouble when trying to attract new talent. If an engineer joins a company valued at $10 million that grows to $1 billion, there is an opportunity to get very rich. That is not the case when joining a company already valued at 10 figures that might slip to six or seven figures.

As for the possibility that Facebook's stock performance might affect other IPO's, Mr. Levie said this could actually help start- ups by allowing them to stave off investors and focus on their business models.

"Ultimately, it shouldn't be anyone's goal to go public; this is just a financing event to create liquidity for investors and shareholders," he said. "I'd be remiss if I didn't mention that there are 8 to 10 companies that make $1 billion acquisitions in the enterprise space. It's mostly the consumer space where this becomes less probable."

He added, "There you really only have one suitor: Google."

Sometimes joining the Billion-Dollar Startup Club is not really as much fun as it might seem.



Source: (C) 2012 International Herald Tribune. via ProQuest Information and Learning Company; All Rights Reserved