Disruptions: A $1 Billion Start-Up Might Not Be So Fun

Disruptions: A $1 Billion Start-Up Might Not Be So Fun

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An image of Mark Zuckerberg, chief executive officer of Facebook Inc., left, with Robert Greifeld, chief executive officer of Nasdaq OMX Group Inc. remotely ringing the opening bell for trading is projected on a screen at the Nasdaq MarketSite in New York.

Congratulations! Your start-up is now valued at over $ 1 billion!

This might seem exciting, as though you’ve won a lottery. But in reality, when you recheck your lottery ticket, you might find you were off by a single number.

You see, being in the Billion-Dollar Start-Up Club limits how, and if, a company can get out of the Billion-Dollar Start-Up 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’re the most expensive product on the shelf, very few companies can afford to buy you. Apple [AAPL  Loading…      ()   ], Google [GOOG  Loading…      ()   ] and maybe Microsoft [MSFT  Loading…      ()   ] are on a short list of corporations that could finance an acquisition of this size without reaching for lint in their pockets afterward.

Given that Apple rarely makes acquisitions, that leaves Google, Microsoft and possibly Facebook [FB  Loading…      ()   ].

And speaking of Facebook: after its lackluster initial public offering, when its stock dropped by half, going public isn’t very appealing. Groupon [GRPN  Loading…      ()   ], valued at $ 12.65 billion before its public offering at $ 20 a share, is now trading at a mere $ 2.98. Zynga [ZNGA  Loading…      ()   ], another member of the Club, is now $ 2.21 a share, down from a high of $ 15.91 this year.

“As a start-up valuation increases, the options definitely decrease,” said Jon Callaghan, a partner with True Ventures who has been investing since the early 1990s. When you’re 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, where 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 nose-dived, and Netflix [NFLX  Loading…      ()   ], which is the closest example of a subscription-based online service like Spotify, also stumbled. 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 woo 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 Facebook’s “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 eight 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 Start-Up Club isn’t really as much fun as it might seem.

This story originally appeared in The New York Times

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