Eval­u­a­tion of Risks & Re­wards

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Industry Leaders - - Content Features -

Is Uber wor­thy of the $62.5 bil­lion price tag?

The en­tire ven­ture cap­i­tal com­mu­nity - in­cu­ba­tors, VCS, busi­ness an­gels, and oth­ers - are con­vinced that of the so­called Uni­corns, Uber’s valu­a­tion is per­haps, too lofty. This is, if Uber’s strik­ingly high valu­a­tion is viewed tra­di­tion­ally. For any­one out­side of the ven­ture cap­i­tal com­mu­nity, it’s dif­fi­cult to make a log­i­cal ar­gu­ment, since they’re not privy to in­side in­for­ma­tion about the com­pany, or its plans for growth.

The me­te­oric rise of Uber and other Uni­corns, val­ued at a bil­lion dol­lars or more, is skep­ti­cal. But, does it mat­ter?

Uber is chang­ing the way the world moves. It’s even more im­pres­sive if you con­sider that fact that five years ago it was lim­ited to San Fran­cisco. To­day, it of­fers rides in more than 65 coun­tries, and its monthly fig­ures have been ac­cel­er­at­ing over time. But again, not ev­ery Uni­corn is ca­pa­ble of pro­ject­ing an end­less up­ward tra­jec­tory, even when it looks like a sure thing. Th­ese com­pa­nies rep­re­sent a new trend in the types of busi­ness

that in­vestors pre­fer. For a com­pany founded five years ago that’s worth $5 bil­lion, for ex­am­ple, has greater time to mar­ket cap­i­tal­iza­tion than a com­pany founded ten years ago that’s worth $8 bil­lion. In other words, to­day’s start-ups are grow­ing about twice as much fast as those founded al­most a decade ago. And they’re star­tups are earn­ing highly volatile valu­a­tion than those of the 1990s. An­a­lysts and ven­ture cap­i­tal­ists sug­gest this re­flects a bub­ble. In fact, in­vestors are over­pay­ing for eq­uity in Uni­corns,

and thereby in­flat­ing their mar­ket cap­i­tal­iza­tion.

Ac­cord­ing to a re­port pub­lished in the Fi­nan­cial Times, in Novem­ber 2015, Fi­delity In­vest­ments had writ­ten down its stake in Snapchat val­ued at $15 bil­lion dur­ing its last fund-rais­ing round by upto 25 per­cent. It was dur­ing the same month that mo­bile pay­ments com­pany, Square filed for an IPO at a price range that could pos­si­bly put the firm’s worth much be­neath its pri­vate valu­a­tion, which was at $6 bil­lion in 2014.

The only pos­si­ble ex­pla­na­tion for such a volatile growth is the fun­da­men­tal forces at work be­hind it. Take for ex­am­ple, prod­ucts and ser­vices, which are get­ting dis­cov­ered and adopted at a greater speed than ever be­fore. Word of mouth does the trick, such that you can see a com­pany get overnight suc­cess. Twit­ter, Tum­blr, Face­book, Pin­ter­est, th­ese all got adopted fast through the most ef­fec­tive means of mar­ket­ing - word of mouth. More­over, the ubiq­uity of smart­phones and sim­i­lar tech­nol­ogy has opened the flood gates to a rare op­por­tu­nity never seen be­fore - to rapidly dis­trib­ute soft­ware for th­ese tech­nolo­gies.

In or­der to grow their com­pa­nies quickly, star­tups are try­ing to raise as much cap­i­tal as pos­si­ble. This gives them greater flex­i­bil­ity, and even more power to fight off ri­vals from the in­dus­try.

CANARIES IN THE GOLD MINE

Re­search sug­gests that in Sil­i­con Val­ley, the amount raised ul­ti­mately mat­ters. Of the 70 com­pa­nies that raised fund­ing since 2000 and have gone pub­lic, there was no long-term value cre­ation be­tween the amount raised to the IPO pre­dicted growth in the mar­ket cap­i­tal­iza­tion after the IPO.

So, if the amount raised doesn’t ac­tu­ally pre­dict longterm valu­a­tion cre­ation, then what does? Stud­ies show that there is an in­ter­est­ing cor­re­la­tion. Com­pa­nies that go pub­lic be­tween the ages of 6 and 10 years, gen­er­ate about 95 per­cent of all the value cre­ated after the IPO.

To­day’s com­pa­nies are not just will­ing to get big faster, but they’re also will­ing to stay

pri­vate for as long as it mat­ters. In that case, it is not clear how the link be­tween the com­pany age and the growth in mar­ket cap­i­tal­iza­tion works out. Do the strong­est com­pa­nies go pub­lic around the same time? Is there a cor­re­la­tion be­tween com­pa­nies that go pub­lic early and very late that hin­ders their abil­ity to cre­ate post-ipo mar­ket cap­i­tal­iza­tion?

So, if the amount raised doesn’t ac­tu­ally pre­dict long- term valu­a­tion cre­ation, then what does? Stud­ies show that there is an in­ter­est­ing cor­re­la­tion. Com­pa­nies that go pub­lic be­tween the ages of 6 and 10 years, gen­er­ate about 95 per­cent of all the value cre­ated after the IPO.

Post-2014, star­tups are in no rush to go pub­lic. Rather, they pre­fer get­ting pref­er­en­tial treat­ment from hedge funds, cor­po­rate VC firms, and mu­tual funds. So, if a Uni­corn re­mains pri­vate much through its growth phase, chances are it may never see a suc­cess­ful IPO. In many cases, we’ve seen in­vestors push­ing com­pa­nies to go pub­lic, sooner, to cash in on the re­turns. Take for ex­am­ple, the pri­vately-held com­pany Jaw­bone, which was founded in 1999, and was once seen as a mar­ket leader in wear­able de­vices. To­day, it no longer ranks among the top five ven­dors in the wear­able mar­ket, and its mar­ket share has seen a steep de­cline. In Novem­ber last year, it an­nounced it was lay­ing off 15% of its staff.

Re­searchers hint that a vast ma­jor­ity of post-ipo valu­a­tion cre­ation comes from com­pa­nies in the so­called pre­mium cat­e­gory - see, Face­book, Tableau, and Linkedin. All of th­ese com­pa­nies have cap­tured more than 70 per­cent of the mar­ket in their par­tic­u­lar cat­e­gory. For to­day’s star­tups, sim­ply rac­ing to the fin­ish line to de­fine new prod­uct cat­e­gories is the real win. For them, sim­ply rais­ing sub­stan­tial ven­ture fund­ing isn’t enough, and cer­tainly not go­ing pub­lic too soon or too late than the de­fined limit.

Bil­lion dol­lar val­u­a­tions are be­com­ing less rare. Ac­cord­ing to The­wall Streetjour­nal, in 19992000, there were 18 pri­vate, ven­ture-cap­i­tal backed com­pa­nies in the U.S. val­ued at a bil­lion dol­lars or more. To­day, there are more than 70 in the United States, and a dozen an­other in other parts of the world. Crit­ics, cer­tainly have the right to point out that mega-val­ued star­tups should sig­nal an alarm. How­ever, a bil­lion dol­lars re­ally isn’t what it used to be.

The def­i­ni­tion has in fact grad­u­ally changed. Take Uber for ex­am­ple, its model for de­liv­er­ing trans­porta­tion is set to in­crease the size of the liv­ery glob­ally. Its valu­a­tion may seem hu­mungous to the mas­sive role in the mar­ket it plays in, how­ever in­vestors are more in­ter­ested in how big the ser­vice can be­come in terms of global trans­porta­tion. In the end, ev­ery­thing comes down to newer tech­nolo­gies and com­pe­ten­cies. When com­pa­nies in­vest to make pre­mium-qual­ity goods and ser­vices cheaper and more ac­ces­si­ble, it makes it even more pos­si­ble for them to capture the mar­ket. When com­pa­nies in­vest to build, owe and man­age their as­sets. The big­ger the sav­ings for the con­sumer, the big­ger their chances of hit­ting dis­rup­tion. A decade ago, an on-de­mand car ser­vice would have looked like lu­nacy, ow­ing to the fact that we were ex­pe­ri­enc­ing a global eco­nomic melt­down. To­day, the com­pa­nies who in­vested to make such ser­vices are reap­ing the ben­e­fits.

Of course, th­ese com­pa­nies run into a fair share of risks. Rang­ing from reg­u­la­tory is­sues to safety is­sues, to pub­lic re­la­tions prob­lems, some of th­ese bil­lion dol­lar ba­bies have a long way to go. But, when you look at them through the lens of dis­rup­tion, it’s ac­tu­ally much eas­ier to grasp how much more worth they could pos­si­bly be than they are. This just shows how mar­ket forces can greatly af­fect the value of a com­pany.

The bot­tom line: be­gin your evo­lu­tion to­day. Ac­ti­vate your net­works by reach­ing out to your cus­tomers, em­ploy­ees, part­ners, sup­pli­ers, em­ploy­ees, and in­vestors and fig­ure out how you can cocre­ate value with them.

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