
Why Twitter's IPO is Bad for Startups - jackaltman
http://jackealtman.com/why-twitters-ipo-is-bad-for-startups
======
patio11
If Airbnb is currently priced at about $2 billion, that's about 1/4 of an IHG
Hotels (they own the Holiday Inn brand and another dozen or so).

That sounds richly valued to me, but not insane. IHG (disclaimer: shareholder
and double super platinum for life due to often staying there for business
travel) has been trying to move, for years, into a capital structure which
Airbnb had from day one: they want a cut of every night's stay without
actually owning any hotel property because that's a capital-intensive
location-dependent slow-growth business. They've got a substantial scale
advantage on Airbnb (~600,000 rooms which each rent 300+ nights per year,
whereas Airbnb does about 50 million nights a year at systematically lower
price points), but 5~10% a year is great growth for them, and Airbnb is
growing at about 100% every 6 months.

There exist significant risks to the company, from the legal issues to merely
not sustaining the hockey stick for long enough to justify the valuation, but
the people with money on the line are mostly rich and sophisticated. If they
lose their investment, oh well, capitalism happens.

It's categorically better than when $X00,000 of pet food sold at a $Y0 million
loss was valued in the billions.

~~~
larrys
"That sounds richly valued to me, but not insane."

The threats to airbnb are much greater (and of course different) than the
threats to IHG.

IHG has a lock on locations because of contracts in addition of course to
locations which they own.

IHG has brands.

And they have standards. You book with them because you expect a certain level
of service when you visit one of their hotels (regardless of who owns the
property). They have a functioning marketing machine which fills up hotel
rooms with conventions and corporate travel.

Otoh, airbnb is much more susceptible to a threat from someone else doing
something similar, slightly different, or essentially the same.

There is a barrier to entry in being IHG as they have infrastructure and an
established brand. To me that makes them valuable.

~~~
Patrick_Devine
I agree with most of your points, but one thing airbnb does have going for it
is a network effect. They have both the supply, and the demand and that makes
it difficult for other people to break into the space. If I'm looking for a
place to stay, my default option will be the place with the most inventory. If
I've got a place to rent out, I want to list it where most people are looking
and where I can get the highest occupancy.

Since airbnb is effectively an exchange, how would another exchange move in to
replace it? Marketing and branding is one way, particularly since airbnb
hasn't fully saturated the market. One strategy might be to include hotel
rooms in listings since airbnb is unlikely to do that given their niche.
Another way might be a series of negative events (eg. a serial stalker or
rampant bed bugs) which could really tarnish their brand.

~~~
toomuchtodo
AirBNB is a commodity to me. I can replace the value they provide just by
pointing my browser to another provider.

That is the double-edge sword of being a tech company. Non-capital-intensive,
but fast growth. Make it work, and make your money fast, because what you're
doing has almost no barrier to entry other than code and server time.

~~~
nikcub
> I can replace the value they provide just by pointing my browser to another
> provider.

I actually can't think of an example of an established e-commerce tech company
with a two-sided marketplace that this has actually happen to.

eBay, Amazon, Paypal, Google, Alibaba etc. - even Silk Road quickly took up a
monopoly position and required the feds to make it go away, it was _very_
resistant to clones that were cheaper, faster, better etc.

It is because they have network effects ^ 2. It is _proven_ that they are
resilient, there is tons of research in the field:

[http://www.hbs.edu/research/pdf/12-024.pdf](http://www.hbs.edu/research/pdf/12-024.pdf)

This is the reason why these business models are so attractive to investors,
the companies are incredibly difficult to bootstrap, but very lucrative.

~~~
larrys
"eBay, Amazon, Paypal, Google, Alibaba etc"

One thing that is different about airbnb vs. the companies you mention is the
amount of interaction as well as the transaction size and importance.

The network effect at, say ebay or amazon, is bolstered by repeated
interaction of small (and of course some large) transactions. That repetition
is important because it keeps the service in the forefront of your mind as the
go to place for many things, not just one thing. I am in the habit of using
amazon so it's my go to place for things. I just bought a ladder from Lowes
only after checking amazon first. Because I buy all sorts of small things from
Amazon and rarely need to visit the Lowes site.

Airbnb otoh has the same thing but to a much lesser degree. The habit part in
other words. Because the amount of time you need a room is less there is less
reason to think about it and more of a chance that (because of the lack of
habit) you might try something else.

Habits (and small transactions) are very important. Starbucks for example
hates to close their locations for renovation because they have found that
once people break the habit many times they fail to return (finding another
acceptable morning place to get coffee.)

------
chaz
I think the Twitter IPO is very good for startups. The wealth event for a lot
of employees unlocks a pool of talented employees who are flush with
experience, ready to take on new challenges, and armed with a network. A bit
of money in the pocket is that they're less dependent upon short-term income
and are willing to take on a fair amount of risk and more focused on long-term
goals. Many will start a new company or join as an early/senior employee at a
fast growing one. Some of them will go on to be angel investors and VCs. Some
will just drive Porsches and play golf.

This cycle has renewed itself many times in the Bay Area, with recent examples
likes Nescape, eBay, PayPal, Google, Facebook, and LinkedIn. I feel this
refertilization is not nearly as strong in many other cities like NYC.

~~~
larrys
"The wealth event for a lot of employees unlocks a pool of talented employees
who are flush with experience, ready to take on new challenges, and armed with
a network."

So essentially the "good" people leave and you end up with a gutted company
lacking the most important people that made it special in the first place.

~~~
hnriot
there isn't anything special about twitter. It's the people that use it that
give it value. your average programmer could build twitter. obviously there
are some scale issues, but the value of twitter has more to do with the users
than the tech behind it.

~~~
benjamincburns
>your average programmer could build twitter. obviously there are some scale
issues, but...

I'm going to be nice and just assume that you're so completely surrounded by
competent and successful people that you overestimate the capability of "your
average programmer" and underestimate the difficulty which Twitter's variety
of "some scale issues" would pose to "your average programmer."

The community is the externally visible thing which gives Twitter value, but
that community wouldn't exist without some really awesome technology providing
it the _capability_ to exist.

~~~
ArtDev
The point is, the original technology is not special at all.

Its about branding, name recognition and value.

That is why Twitter is not overpriced at all. Neither is Facebook and that
website sucks :)

~~~
benjamincburns
No, the point is that the original technology is _incredibly_ special, but the
simplicity of the service and the "big data" boom it helped create makes it
all look insignificant in hindsight.

I challenge you to go set up a twitter clone using only software which existed
in, say, 2008 or earlier, or software which you write 100% yourself. To test
it, rent a small swarm of AWS servers and get 10,000 fuzzing clients to hammer
on the thing. Should be a fun weekend project, right?

I agree with the sentiments about the brand and the community, but anyone who
thinks that just magically appeared like it was some inevitable fatalistic
force of history is dead wrong. It took a ridiculous amount of ridiculously
hard work by ridiculously smart people. And if anything the fact that I have
to point this out is a testament to how excellent and valuable their work
really is.

------
nikcub
> This valuation (along with the recent surge in Facebook stock) will send a
> rising tide of valuations rippling down through the ecosystem until “my
> friend and I have a pitch deck and an idea for a web app” is worth $10
> million.

The opposite has been shown to be true (and correlated with my own experience)
for early stage companies. The biggest startup valuation bubbles happen when
there are no public tech companies for money to be invested in (eg. the '07
startup bubble and more recently in '11).

With Facebook, LinkedIn, Pandora, and now Twitter etc. public early stage
startup valuations have shrunk again.

Where it does get competitive is in the later stage rounds, but that was
happening anyway as the mega-funds like DST competed with traditional VC and
mezzanine funding (the business model here changed, as companies wanted to go
public later).

> Snapchat and Pinterest are worth around $4 billion dollars each. Evernote
> and Airbnb are each worth over $2 billion. Path is worth $500 million.

Snapchat never raised on $4b, that was a rumor (and it continues to get cited
as signs of a bubble even though the round never happen). The only other
valuation here that would be out now is Path, and that is only because that
startup has struggled. Were it a real bubble, Path would not have any problems
raising a new round at $1b, fact is they are laying people off and searching
for bridge loans from friends).

> “People who think the company is overvalued,” they scoff, “just don’t get
> the power of Twitter.”

There is nothing magic to understand, the business model is centuries old -
sell services to individuals whose attention you have. Twitter currently has
250M subscribers, larger than most traditional media companies (that required
printing presses, expensive TV spectrum to be purchased, entire studios like
30rock, dealing with the politics of media ownership, expensive distribution
etc.) and growing quicker.

I am a twitter user, I don't watch television anymore and I don't pick up
newspapers or magazines. For advertisers to reach me and people like me, they
need to find me on Twitter (or others on Facebook - this is the competition).

The Twitter IPO is _great_ for startups, for a few reasons: first, it returns
money to investors who will inturn invest in the next generation of startups,
it reinforces the hit parade and that the industry depends on, and it will
bloom and entire new generation of angel investors who will be supporting the
ecosystem (in the same way former Google employees did 10 years ago and FB
employees did 2 years ago).

edit: and I think the Buffett quote argues _for_ Twitter, i've seen that quote
used before to argue against Bitcoin, but not against an actual company that
is producing hundreds of millions of dollars in revenue and growing at almost
100% a year.

------
davidu
I think lots of things are bad for startups, but Twitter's IPO isn't one of
them -- and this post didn't convince me otherwise.

In fact, lots of points made in this post seem to sound as though they are
factual, but I'm not sure they are and would likely argue the opposite point
of the author:

"The real problem here is that we increasingly live in a world where
technology companies are valued on emotional whims and promises of
unbelievable future growth."

Technology companies are almost universally about promise and potential and
always have been. Read Crossing the Chasm to understand why that is. At the
time that the private market investors care about them, they are so early in
the selling motions that their early success in a tiny subset of the market is
indicative of later potential. That's why VCs exist. To see something with
early potential, pay a premium (at times) to get a part of it, foster it's
development, and then ride it into reality and receive a terrific return for
the foresight and fortitude.

The pattern recognition there is unmistakeable. Where it gets challenged is in
the fickle and finicky consumer market where externalities are more likely to
cause massive changes in momentum (See: Path can't maintain the momentum of
fundraising).

"A surge on IPO day is good of course, but 15-20% is more than enough; 75%
simply means the company was mis-priced and that Twitter left over a billion
in cash on the table."

This is also not a factually true statement. Because a small float was
offered, and demand was prescriptive by the bankers, it's impossible to say
that because of how it ended, trying to raise the price to $40 would have
resulted in the same outcome.

If Twitter wanted to fully maximize their first day gains, there are dutch
style IPO auctions that can be done to better match demand for an offering.
Google did this.

I'm not going to continue, but I guess this is a great headline with a poorly
made point. I'm not sure what the goal here was.

~~~
jackaltman
I understand that startups are about promise and potential, and that a company
with no revenue might be fairly valued at billions of dollars.

A startup (or any company) is worth something like the integral of of the
graph of probability vs. outcome. The problem I see right now is that people
are overvaluing the positive outcomes and discounting the low end.

"Because a small float was offered, and demand was prescriptive by the
bankers, it's impossible to say that because of how it ended, trying to raise
the price to $40 would have resulted in the same outcome."

I'm not completely sure what you mean by this, but I spent time on an ECM desk
one summer and I they aren't aiming for a 75% first day pop. The bankers get
paid less, the company raises less. You want a pop to satisfy buy-side clients
and to keep a positive public perception, but 75% is too much.

~~~
ojbyrne
Twitter's revenue for the first 3 quarters of 2013 was $422.2 million
([http://finance.yahoo.com/news/twitters-
debut-164047360.html](http://finance.yahoo.com/news/twitters-
debut-164047360.html))

------
AndrewKemendo
>Snapchat and Pinterest are worth around $4 billion dollars each. Evernote and
Airbnb are each worth over $2 billion. Path is worth $550 million. By
comparison, Peabody Energy, the largest coal company in the world which owns
almost 10 billion tons of coal, is worth about $5 billion.

I see fewer and fewer comparisons like these between tech companies and brick
and mortar/commodity companies and I think it is a shame. To me such
comparisons do more to highlight how broken the financial markets are, though
I am not exactly sure why. It seems like investment priorities or consumer
demands are out of whack when electrical utility companies (PEPCO) are valued
less than social media platforms (FB).

~~~
kooshball
> It seems like investment priorities or consumer demands are out of whack
> when electrical utility companies (PEPCO) are valued less than social media
> platforms (FB).

This is really not a logical comparison. These are 2 companies in different
fields and have very different characteristics. Investors almost certainly
have different reasons from buying one or the other. The comparison between
their value is not really relevant.

~~~
infinii
That's what's broken. The fact that "value" is irrelevant. Imagine life
without utility companies and imagine life without FB. It's absurd.

~~~
hrjet
What you are supposed to see there is not "value" but "profit and potential".

If a utility company which provides basic necessities were to make a lot of
profit, wouldn't it be sort of a bad outcome for humanity? Isn't it better if
basic necessities are provided to us at the most affordable prices?

------
zaidf
Twitter IPO is bad for start ups because its fueled by inexperienced investors
who missed out on Facebook. What they don't realize is that twitter is no
where near facebook's trajectory on any of the metrics that matter(revenue,
profit, user growth).

~~~
tomphoolery
I'm not sure "inexperienced" investors "missed out" on Facebook. It was a very
risky purchase, and for a few months there lost quite a bit of money for a lot
of people. Only until the stock really stabilized did we see it sort-of hover
around the $30-50 range. And even then, I feel it's priced much less at the
moment than many people thought it would be when it IPOed. It even made a few
acquisitions like Waze and Instagram in order to boost its investment value,
but the main product still isn't as valuable (on Wall Street, that is) as
people thought it was going to be. In my opinion/from what I've read, anyway.

------
DenisM
The article doesn't actually answer the headline question. So, valuations are
running sky-high. Ok. Why is it bad for startups?

~~~
jackaltman
The answer to the question is supposed to be "because it's driving startup
valuations sky high", which I assumed is understood as a bad thing, but I see
your point. I have written about that before - it has all sorts of problems
like trouble with fundraising for later rounds, inability to get acquired,
etc.

~~~
alexeisadeski3
First world problem: "I can't get acquired because my valuation is sky high!"

Just sell for less. If everyone else demands high valuations, it's easier to
sell, not harder.

~~~
byoung2
_Just sell for less_

Your investors gave you $50 million at a $500 million valuation. Google wants
to acquire you for $100 million. Your investors may not let you.

~~~
RyanZAG
That's a nice position to be in. Disolve some of your shares: investors take
$70 million, you take $30 million. Everyone should be very happy.

Or if you still have runway and believe in the business, keep going and raise
that $100 million.

It sounds like the problem of having scaling issues: it's a problem, sure, but
it means you're already a success. If you never got that $50 million to begin
with because valuations weren't high, then you might be a failure now instead.

~~~
byoung2
_That 's a nice position to be in. Disolve some of your shares: investors take
$70 million, you take $30 million. Everyone should be very happy._

Be sure to check your term sheet. It could be that your investors have a
liquidation preference that includes a multiple. Based on my (admittedly
limited) understanding, if your investors gave you $50 million for 10% of the
company, with a 2X multiple liquidation preference, they would be entitled to
the first $100 million of any sale, plus 10%. So you may be able to sell for
$100 million, but you wouldn't see a dime.

------
pyrrhotech
Blame bubble Ben. QE is 90% of the issue here. The market is addicted now.
Great recession 2.0 will probably hit next fall

------
pkinsel
I agree that valuations are too high for companies with low or nonexistent
revenues. However, this analysis ignores a) startup ideas and their
opportunities are unique and b) markets are winner take all.

You lost me with the trickle-down argument, “So if Twitter is worth $25
billion and its size is X,” thinks the VC to himself smugly, “this other
startup must be worth $250 million because its size is 0.01X.”

Is the other startup doing something as unique and compelling? And does that
startup have the opportunity to own that equally unique and compelling space
outright?

Twitter's valuation is born from its opportunity to be THE real-time
information platform for the web. I would argue that Snapchat's opportunity
(to be yet another photo social network) is nowhere near as compelling.

Sure, valuations are too high across the board, but I do not see Twitter's IPO
as bad for startups. If anything, it shows that unique concepts with the
opportunity to own their market globally are highly rewarded by the public
markets.

As is often the case, I agree with much of your content, but take issue with
your sensational headline :)

------
neovi
I love these posts, ones that deal with understanding the investment side of
startups. With that said, I hope you could reply because I'm an amateur in
this field compared to you [quick google search] and would like to learn from
this discussion.

\- who are you going after here? In your post the people I see are the
unsophisticated investors who go for emotion/speculation rather than business
perspective. Those that say with their gut "I love this product, it's so
influential, therefore it's worth $50/share" and do off-the-cuff calculations
"Facebook is priced at X so Twitter is around X, too" instead of doing hard
research. One can see how it's bad to have these kinds of people involved in a
relatively small field (ie VC), but again, your headline is towards startups
and not the investors just noted.

\- don't startups stand to profit most from these valuations? The problem I
see is in having the aforementioned investors. If we have people running
around trying to get a slice of the pie, it looks like they'll pump-and-dump.
They'll pump their cash into whatever startup seems to have a chance of
opportunity and then walk out when it's profitable enough. Win/win, except
that means the investors don't really care what the company is doing or up to,
they just want to profit.

\- with what I just mentioned, startups stand to profit because more
opportunity is available. The downside I see is there being a higher chance of
shallow investments. When investing in a company, you want to really
understand it and know it, but with these valuations and profits, it seems the
headline shouldn't be "Why Twitter's IPO is Bad for Startups" but "Why
Twitter's IPO is Bad for Sophisticated Investments."

note: It's pretty difficult trying to write out thoughts on here, so hopefully
I made some sense. If not, just ignore it as beginner's mind.

------
wepple
$4bn for snapchat? These kinds of valuations don't stack up to me - sure,
startups are speculation not investment, but a four billion dollar valuation
is an incredibly hefty speculation.

my bet is that these billion dollar speculative valuations will continue
amongst growing startups until a few of them fail to build solid profitability
and fold - then we'll have a classic bubble burst through lack of share market
confidence, and availability of cash and growth with slow.

then, cue blog posts about "the virtues of being an organic-growth hacker"

------
sjtgraham
> “So if Twitter is worth $25 billion and its size is X,” thinks the VC to
> himself smugly, “this other startup must be worth $250 million because its
> size is 0.01X.”

Isn't the main justification for these valuations growth and potential maximum
size? Surely an investor can't extrapolate a $250MM valuation based on
relative size with a straight face, especially as their metrics will also look
quite different.

------
vampirechicken
The market is not rational. To not ascribe rationality to the market. Do not
anthropomorphize the market.

------
Guest98130
Anyone catch the latest episode of Dragon's Den Canada yesterday?

[http://www.cbc.ca/dragonsden/](http://www.cbc.ca/dragonsden/)

I think that's only viewable in Canada, but Canadians, play the video and
watch the first pitch.

These kids develop an iPhone app for tracking and recommending your workouts.
They're asking $100,000 for 10% of their business. Their plan for generating
revenue is converting users from their free app to pro at $4.99/mo, $29.99/yr.
So far, 12,000 downloads on their app, and they say 1% are converting to paid.
That means 120 paid users, averaging say $15 each, so they've made roughly
$1,800 in revenue.

What the hell? $1,800, and they value their company at one million dollars?
They're not even paying themselves, and they're in one of the most saturated
niches in the world, with already countless others well established and
successful in that market. What blows my mind even more, one of the investors
offers $100,000 for 20%, with 25% royalties until they're paid back. They turn
it down.

------
anovikov
Twitter has a power to change the fates not of just people, but of whole
nations. Coal on the other hand, is intrinsically worthless: we have more coal
than we can afford to burn due to global warming, so availability of coal is
not a limiting factor.

------
anuraj
Just a correction - Coal India Limited
([http://en.wikipedia.org/wiki/Coal_India_Limited](http://en.wikipedia.org/wiki/Coal_India_Limited))
is the largest coal company in the world - not Peabody Energy.

~~~
jackaltman
CIL is a public company in the ran-by-a-government sense, so it's a little
different. BTU is the largest private sector coal company.

~~~
anuraj
CIL is a publicly listed company though govt is the biggest shareholder. You
are right about the private part.

------
beautybasics
Imagine we were in 1890's

\- There is biggest horse carriage company

\- And a dominant railway company

Here comes { Ford, GM, Cadillac........}

Every investor at that time can make a case that how could a transnational
railway/carriage company is worth less than any motor company.

~~~
AndrewKemendo
I think the difference is that in your case tangible commodity assets are
being compared to tangible commodity assets. Those machines can be re-sold,
melted for scrap, re-purposed etc...

Software has a much harder time in the secondary market.

------
AznHisoka
All valid points, but a bit too removed from the 99%.

Here's the real reason Twitter's IPO is bad for most startups:

Their API is no longer going to be free in the future. That or they're going
to impose harsher rate limits.

------
brackin
Coming from an investor, they're obviously looking for better terms. This is a
somewhat biased perspective.

------
l33tbro
"Once my sympathies for Twitter subsided ... " Right, so when is the
candlelight vigil again?

------
dinkumthinkum
Snapchat ... $40 billion ... ? Does money not mean anything anymore?

------
thejosh
not making money is bad for startups.

~~~
davidu
There's no factual evidence to back this statement up. See my other comment on
this thread.

~~~
thejosh
What?

Not making money isn't a bad thing for startups? I must be really out of the
loop, I didn't realise startups run on Unicorn smiles and jellybeans.

~~~
davidu
Many run on capital raised from investors until which point they reach a
liquidity event that exists irrespective of making money.

Some also make money.

But VC-backed startups, which is really the only connotation of startup that
we use here on YC, are a special breed of startup (generally focused on
massive growth) where operating capital derived from revenue is not a pre-
requisite for success.

------
crassus
Twitter/snapchat are media companies in competition with prime time television
and daily soaps. It's okay, IMO, if justification for their valuation consists
of mushy statements about user feelings. It's their business.

------
rafe33
Uh, "Path is worth $550 million" ?!

What crack is he smoking?

~~~
hansy
[http://techcrunch.com/2013/07/16/path-is-
raising-50m-at-a-50...](http://techcrunch.com/2013/07/16/path-is-
raising-50m-at-a-500m-valuation/)

~~~
yanivs
actually Path is valued at $250m

[http://techcrunch.com/2013/11/07/path-loses-biz-head-amid-
ru...](http://techcrunch.com/2013/11/07/path-loses-biz-head-amid-rumors-of-
over-7m-in-funding-from-dustin-moskovitz/)

~~~
hansy
Oh wow this article is only a few hours old. My bad. Nice find!

