When I wrote the valuation model for Pinterest, many people wrote to me to point out that Pinterest stopped using SkimLinks and hence stopped making any revenue. Making revenue it turns out is not good for your startup (don’t quote this line out of context).
How do you value an investment? Any investment, be it a farm , shares of an established enterprise or a tech startup?
Simple answer is, you look for profits they generate now and how it is expected to grow.
But that level of transparency and simplicity is a problem for venture capitalists investing in Silicon Valley’s startups. The New York Times Bits blog says why VCs don’t want the startups to show any viable business model let alone profits,
“It serves the interest of the investors who can come up with whatever valuation they want when there are no revenues,” explained Paul Kedrosky, a venture investor and entrepreneur. “Once there is no revenue, there is no science, and it all just becomes finger in the wind valuations.”
With any hint about business model one can come up reasonable valuation models for any business. Granted one has to make assumptions to get there but we can quantify the uncertainties in the assumptions and state our valuation in terms of probabilities which can be used to place bets (I mean investment).
That is not good because
they’re interested in pumping up enough hype and valuation to find a quick exit through an acquisition at an eye-popping premium.
How else can you justify $200 million valuation for Pinterest when its chances of making revenue that justifies such a valuation is less than 0.25 percent?
This seems to explain why VCs advice startups to give their product away for free and why VCs don’t advice startups about customer segments and filling an urgent need. As Stanford’s Pfeffer says,
These companies are simply being founded to be bought.
Not to fill an urgent need and to take their fair share of value created.