Start-Ups Awash in Dollars, Again by Brad Stone and Matt Richtel
Oct. 16 Silicon Valleys math is getting fuzzy again. Internet
companies with funny names, little revenue and few customers are commanding
high prices. And investors, having seemingly forgotten the pain of the first
dot-com bust, are displaying symptoms of the disorder known as irrational
the popular but financially unproven social network, which is reportedly being
valued by investors at up to $15 billion. That is nearly half the value of
Yahoo, a company with 38 times the number of employees and, based on estimates
of Facebooks income, 32 times the revenue.
recently surged past $600 a share, is now worth more than I.B.M., a company
with eight times the revenue.
Internet start-ups are drawing investment based on their ability to build
an audience, not bring in revenue the very alchemy that many say led
to the inflation and bursting of the dot-com bubble.
The surge in
the perceived value of some start-ups has even surprised some entrepreneurs
who are benefiting from it.
A year ago,
Yahoo invested in Right Media, a New York-based company developing an online
advertising network. Yahoos investment valued the firm at $200 million.
Six months later, when Yahoo acquired Right Media outright, the purchase price
had swelled to $850 million.
According to Right Medias chief technology officer, Brian OKelley,
very little, except that Yahoos rivals, Microsoft and Google, were writing
billion-dollar checks to buy online advertising networks, and Yahoo thought
it needed to pay any price to keep up.
to say I giggled, Mr. OKelley, 30, said of the deal that earned
him millions. He has since left Right Media and is starting another company.
There is no way we quadrupled the value of the company in six months.
The trend is
described as a return to madness (by skeptics) or as a rational approach to
unlimited opportunities presented by the Internet (by true believers). Greed,
fear and a desperate rush to pick the next big winner are all adding fuel
to the fire that is Silicon Valleys resurgence.
definitely a lot of betting going on, and its not rational, said
Tim OReilly, a technology conference promoter and book publisher.
is credited with coining the phrase Web 2.0, which refers to a
new generation of Web sites that encourage users to contribute material. His
Web 2.0 conference, which begins Wednesday in San Francisco, has become a
nexus for the optimism around the latest set of society-changing online tools.
But that has not stopped Mr. OReilly from worrying that the industry
is minting too many copycat companies, half-baked business plans and overpriced
When the bubble
inevitably pops, he said, there are going to be a lot of people out
of work again.
Putting a value
on start-ups has always been a mix of science and speculation. But as in the
first dot-com boom and the recent surge in housing, seasoned financial professionals
are seeming to indulge in some strange instinct to turn away from the science
and lean instead on the speculation.
This time around,
people indulging in that optimistic thinking are not mom-and-pop investors
or day traders but venture capitalists whose coffers are overflowing with
money from university endowments and hedge funds. Many of those financial
professionals say that this time, everything is different.
More than 1.3
billion people around the world use the Internet, many with speedy broadband
connections and a willingness to immerse themselves in digital culture. The
flood of advertising dollars to the Web has become an indomitable trend and
a proven way for these start-ups to make money, while the revenue models of
the dot-coms of yesteryear were often little more than sleight of hand.
factors are much different than they were eight years ago, said Roelof
Botha, a partner at Sequoia Capital and an early backer of YouTube. The
cost of doing business has declined dramatically, and traditional media companies
have also woken up to the opportunities of the Web.
open up the aperture for a different outcome this time, he said.
Some trace the
start of the new bubble to eBays $3.1 billion acquisition of the Internet
telephone start-up Skype in 2005. EBays chief executive, Meg Whitman,
reportedly outbid Google for the company. This month, eBay conceded it had
grossly overpaid for Skype by about $1.43 billion, and announced that Niklas
Zennstrom, a Skype co-founder, had left the company.
acquisition of YouTube last year for $1.65 billion, under similarly competitive
bidding, might have accelerated the transition to loftier values. Google executives
and many analysts argued that YouTube was well worth the price tag if it became
the next entertainment juggernaut.
It still might.
More than 205 million people visit YouTube each month, according to the research
firm comScore. Still, Citigroup estimated that YouTube would bring in $135
million in revenue next year. At that rate, YouTube would have to grow considerably
to account for just 5 percent of Googles annual revenue of nearly $12
almost going back to year 2000 types of errors, said Aaron Kessler,
an Internet analyst at Piper Jaffray. Internet companies are buying
users instead of revenue and profitability, he said.
The Skype and
YouTube windfalls helped to give the newest batch of Internet entrepreneurs
dreams of improbable wealth. They also brought back practices that had seemingly
been discredited during the first boom. For example, in the first dot-com
gold rush, Internet companies did not have to make money to acquire serious
investments dollars. Now that once again is true.
Twitter, a company
in San Francisco that lets users alert friends to what they are doing at any
given moment over their mobile phones, recently raised an undisclosed amount
of financing. Its co-founder and creative director, Biz Stone, says that the
company was not currently focused on making money and that no one in the company
was even working on how to do so.
moment, were focused on growing our network and our user experience,
he said. When you have a lot of traffic, theres always a clear
That is not
necessarily illogical in the current climate. A European competitor, Jaiku,
which is similarly devoid of a mature business model, was acquired last week
by Google for an undisclosed sum. With the competitive logic that prevails
at the major Internet companies, the deal might have further raised Twitters
appeal to Googles rivals.
The high value
placed on many start-ups and minimal requirements for financial performance
are raising expectations of other entrepreneurs. Sharon Wienbar, managing
director of Scale Ventures Partners, an investment firm, cited the $100 million
valuation that investors gave to the Internet genealogy site Geni.com, founded
last year in Los Angeles by a veteran of PayPal.
entrepreneur thinks he should get that, Ms. Wienbar said. I have
a feeling a lot of entrepreneurs are secretly meeting for beers on the Peninsula,
saying, Hey, look what I got.
formerly of Right Media, said other entrepreneurs had begun to think that
the financing game is best played by avoiding actual revenues since
that only limits the imagination of investors. Its a screwed-up
incentive structure, just like you had in the first bubble, he said.
benefiting from the exuberance is Ning, which allows users to create their
own MySpace-style ad-supported social networks. It was recently valued by
investors at more than $200 million, mainly because its main backer and founder,
Marc Andreessen, has a successful history with the Internet hits Netscape
argues on his blog that there is no bubble and that the high prices represent
a rational desire to stake a claim in the potentially huge markets of the
future. But he acknowledges that a seemingly inexhaustible flood of capital
into Silicon Valley is helping to power the boom. Venture capitalists are
flush with cash from institutional investors, eager for Internet-style returns
on their money.
valuations pressure is the result of decisions being made by people wearing
suits in cities like New York and Boston who would never ever meet with start-ups,
Mr. Andreessen said in an interview. If that ever goes away, it will
have consequences. But it doesnt look like they will change their minds.