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I hate to leap in with what seems like an ad-hominem attack on the 37 signals, but their utter and complete misunderstanding of all the basics of business is starting to grate on me, and I'm wondering if it has anything to do with Chicago. Is the problem that they're sitting there in a city without any other Internet industry, stewing in their own witty ideas, listening only to the adoring comments they get from the groupies? How else could you explain just how far they seem to have drifted away from basic reality?

First of all, David: The word is VALUATION, not evaluation. KTHX.

Secondly, EVERY SINGLE COMPANY IN THE WORLD that has shares that trade is valued by taking the last share traded and multiplying by the number of shares outstanding. It's just the DEFINITION of valuation. It's TAUTOLOGICAL.

The whole section "Minority investment evaluations aren’t real" is so economically bizarre and incorrect that I don't even know where to start. It's like you wrote a blog post arguing that it is incorrect to refer to a 5' tall boy as 5' tall because he's often sitting down. Every single day every single public company in the world is valued by the last share traded, usually for a tiny fraction of the company.

Finally, to the main point. Facebook has certainly figured out how to make money off of 500,000,000 users. And as they optimize, they will make a lot more money. When they figure out how to make another DIME off of every user, they will instantly be making another $50,000,000 a year... in pure profit. How much profit will 37signals make if you figure out how to make another dime off of every customer? Eh David? Facebook works on the theory that when you have a lot of people, you don't have to make as much per person, because the amount of money you make is the number of customers times the amount of money you make off of each one. Again, that pesky multiplication.

It's weird, it's like in Chicago they don't have multiplication or something.

1. Thanks for the word correction, updated.

2. Publicly traded companies have instant liquidity on many more shares, which makes using "last share sold" an meaningful metric.

3. When only 3% of the money a company is supposedly worth has been moved around, it's a poor indicator of what the other 97% would go for.

4. They haven't figured out how to make much profit yet. And it's still questionable whether they will. MySpace supposedly also just needed to turn on the faucet, but apparently the water ran out before they got to it.

5. Oh, and New York smells. (take that!)

2. That's just not correct. Spend twenty minutes talking to anyone who trades in bonds or equity before you make assumptions about what liquidity you need to get a good price... it's not much. Facebook trades all the time on sharespost, certainly enough to be liquid and to reach a market price. Google itself only has a tiny fraction of the shares available to the public (10% if I remember correctly) and far less than 1% of the outstanding shares trade every day. That doesn't mean that the market doesn't find a market price.

3. Also not correct. When entire companies are bought and sold that had a previous market in the shares, the price for the entire company is usually a PREMIUM ON the the market valuation. "PREMIUM ON" means MORE THAN. Somewhere in Chicago, I understand that there is one market of some sort, I think they trade corn and pig bellies, surely SOMEONE there can explain it to you...

4. Also, just not true. They are very profitable and their profit is almost certainly growing at a rate that will make their valuation reasonable.

2. The bond and equity markets are based on sound regulation, transparency, and quarterly statements. Facebook has none of those things when it operates in the dark of the secondary markets.

3. Again, these premiums are based on outstanding shares traded under the transparency of the public stock market. See Secondary Suckers for a nice take on the perils of the secondary market: http://www.homethinking.com/brontemedia/2010/09/17/secondary...

4. Do you have their P&L handy to back that up? If the valuation was so wonderful and they were raking in the profits, then taking series E funding three months ago doesn't make much sense.

Point of order... It wasn't a series E, it was $120 million in purchases on the secondary market


This is an extremely important point, germane to the conversation.. The $120mm was not a funding round -- it was liquidity for founders. Huge difference, and it invalidates much of dhh's original analysis.

These are all valid points, but they are logically equivalent to saying "I don't understand why anyone pays $12 for a Ke$ha album".

You may not agree on the worth of the album or of the shares, and nobody is forcing you to buy either one. That some people do consider it a good price is enough to result in a market price for both, on the basis of which many decisions are made.

Well, no, it's like saying "I don't understand why anyone pays $12,000 for a Ke$ha album." If the price was broadly reasonable, there would be no argument. But if the price gets outlandish, then someone needs to call B.S.

And yes, this happens now and then for ordinary, exchange-traded companies. Usually, it results in the exchange suspending trading for the company for a bit. Sometimes, it requires someone to call B.S. In an ordinary, regulated market, one or the other of those actions restores sense, gets the price back somewhere within shouting distance of reasonable.

Not true, b/c as far as I know nobody is buying Ke$ha albums at $12K, while there are many investing in FB, hence the notion of a market price.

Not sure what phenomenon you're referring to in your second paragraph.

Actually I don't understand why anyone buys a Ke$ha album at any price...

> The bond and equity markets are based on sound regulation, transparency...

Presumably subprime mortgage backed securities are the exception that proves the rule...

Exception that proves the rule means that since their is an exception a rule must exist.

For instance - Tonight we got an exception and are allowed to stay out till 11pm, would imply that there exists a rule that forbids them staying out that late. Hence the exception proves the rule.

The stock market is well regulated but the bond markets a lot less so, hence that's where Wall Street makes big profits (when times are good.) They make serious profits as 'market makers' (standing between buyers and sellers) with bonds.

You view the bid/ask spread as an indicator of poor regulation? Not actually true.

The spread reflects the willingness of firms to compete as market makers. More firms competing means a smaller spread.

The spread also reflects the risk associated with the market maker holding inventory. The more perceived risk, the bigger the spread.

Do YOU have their P&L handy to back up YOUR statements about how they have no idea how to monetize their users? Or is that only a valid critique of people who are arguing with you?

Maybe the equity markets. The bond markets not so much.

Also, Sharepost currently has 3 positions for sale at valuations between 33 and 44 billion. The total outstanding shares for sale represent 0.001% at 44B.

That's pretty close to the 0.000000001% that put our $100B valuation on paper: http://37signals.com/svn/posts/1941-press-release-37signals-...

But hey, you better snatch these shares up quickly. It's rare that you get a chance to a clear shot at a company where "profit is almost certainly growing at a rate that will make their valuation reasonable". How much can I get you down for, Joel?

If you're selling another 0.000000001% of 37signals, put me down at $10. Being a minority shareholder of 37signals and putting "increased the value of 37signals 10x" on the CV has far more than $10 of cachet ;-) (as Microsoft realized with FB).

6 orders of magnitude is not pretty close.

His $1 trade was in jest. The point is, both are very small numbers compared to 100%, or even 1%.

Uh, Joel, have you bought any Facebook stock on Sharespost?

Valuing Facebook just by the market price on Sharespost is like predicting the outcome of an election when only 1% of the votes have been counted. Maybe those votes are a representative sampling, maybe not.

I'm inclined to think not, because you have to be an accredited investor, ie already wealthy, to buy pre-IPO shares. Facebook's investors are there for the potential upside and are more comfortable with risk than Joe Blow saving for retirement or his kid's college education.

So Sharespost prices will be higher because (PROB_FB_DIES * NEG_UTILITY_FORME_IF_IT_DOES) will be less negative for millionaires than for the middle-class people or conservative mutual fund managers who will buy most of Facebook's equity when the company goes public.

Predicting the outcome of the election when only 1% of the votes have been counted is sometimes known as polling.

I'm inclined to think not, because you have to be an accredited investor

You "only" need $1 million in net assets (minus the house due to recent law I believe) to be an accredited investor. I would really be surprised if Joel didn't have at least that much.


I think the simple summary of your point is this: Things are worth what people are willing to pay for them, not what other people think they should be willing to pay for them.

Facebook is worth $26 billion. That doesn't mean that buying it at a valuation of $26 billion is a good investment. Worth and my estimation of what it will be worth in the future two are different things.

"Things are worth what people are willing to pay for them, not what other people think they should be willing to pay for them."

I agree with this, but there is a difference between the market being willing to pay $26 billion for a company, and minority investors being willing to pay $26 billion/0.03. Only the former establishes the actual* value.

Now, now. Let's be reasonable. No one is valuing Facebook at $866.67 billion.


That is sharespost's estimate of Facebook's worth, not what Facebook is actually worth. Hopefully if this thread was a little less heated, at the basics this is a discussion on estimating the present worth of Facebook.

A decent estimate would include the expected future worth, whether it is based on expert analysis or a market's expectations. I don't think any estimate here could be categorized as what "it will be worth in the future".

Estimation beats market cap when it comes to the sustainable value, which only comes from hard-earned cash, not crazy bomb-passing games you can observe in every bubble scene. I do think that FB can be traded around $50 billion and may be $500 billion (Who cares? Most of investors-speculators don't care about its paper worth on the market.) if another dot-com bubble forms. However, what would be its sustainable value? How will it generate its profit to justify its valuation? Until it's on its verified earnings statement, it's just another bomb-passing game. Who really care whether it's $5 billion, or $500 billion, if one believes he can pass his bomb to the enthusiastic guy beside him?

I know you were being facetious, but agricultural derivatives are totally different from equities. But we do also have a stock exchange and options exchange in Chicago, you know.

Anyway, the primary reason that your point 3 is true is because of basic supply and demand. It is harder to buy all the shares than to buy a few. When it's perceived there's a very small number of shares available--I don't know if this is true, but it does seem like investors are clamoring to invest in Facebook--share price will be higher than if that were not the case. In particular, perceived scarcity can share prices artificially high. The idea of getting a slice of the pie before someone else does was a big factor in the dot-com bubble, for instance.

Sheesh, did this topic hit close to home or something? Someone needs to chill and lay off Chicagoans, or red bull, or something..

Doesn't it come down to who comes up with the price and what their motivation for investing is?

When a VC invests in a company, they're looking for a big exit. Essentially, they're trying to predict how much the company might IPO or get acquired for. A public investor is trying to predict the rise in future profits of the company. The difference in motivation matters when you consider a hypothetical.

Suppose the company is guaranteed to have stagnant or falling profits. Does that discourage the VC? Not necessarily. They don't care about whether the company can make money. They care about whether they can keep building perceived value in the eyes of anyone who would want to acquire. A public investor, however, would not put their money in that company (at least not for long).

Therefore, I think David's main point is sound - VC's are more likely to over-value your company than the market is. We also know this to be true because of what happened in the early 2000's.

Hi Joel, ex stock analyst here. What you say re minority trades is correct in so far as that is the way market valuations are calculated. However, what David says is also correct: just because someone pays X for a tiny fraction of the company doesn't mean someone else will pay the same for all of it.

Wily investors always look for meaningful volumes before taking big jumps/declines in share prices seriously.

One of the easiest ways to ramp a stock (apart from getting your journalist buddy to write a puff piece) is to continually lift the offer for small volumes.

As Joel points out, it's tautological. How many companies would buy up Google for it's current market valuation? Apple? Since no buyers have tried to do that, are they ipso facto no actually worth that market cap?

Yes, but Google's valuation is confirmed by trading volumes.

In the early days of computerized trading it was quite common for even quite liquid stocks to be suspended limit up/down because of programming bugs.

But by Joel's logic, the market has 'spoken' and these companies are now worth 10% more/less than 30 seconds prior, when in fact all that has happened is some faulty code just ripped through the book on minimal volumes.

The point is that 'true' valuations are validated by significant volumes. Hence Google's valuation is real. Depending on your viewpoint, the size of the recent transactions in FB may or may not be material - and I think this is the point that David was making.


You need some amount of liquidity to make a meaningful valuation. Lack of liquidity leads to price volatility. Think May 6 flash crash.

Hey! Ad-hominem the 37 signals if you must, but leave Chicago out of it!

It's weird, it's like in Chicago they don't have multiplication or something.

Oh, and New York smells. (take that!)

Two of my heroes dragging discourse on hacker news into the toilet. What's the world coming to?

Apparently it wasn't obvious from the "New York smells" point that it was a joke. So let me spell it out: It was a joke (even if it's actually, technically true. Many parts of New York really do smell from all that trash on the street!).

people don't have a sense of humor. obviously my comments about chicagoans not knowing how to multiply was a joke, too. They multiply like bunnies.

Let this be a lesson to you edw519: you make a joke, and both your heroes attack you! Biff! Bam! Actually, I can't imagine a funnier response.

Ah, the Chicago-New York feud, older than Hatfield–McCoy.

Joel's comment:

Is the problem that they're sitting there in a city without any other Internet industry, stewing in their own witty ideas, listening only to the adoring comments they get from the groupies?

.. is a often genuine criticism of 37s here on HN. Probably part of the reason the joke was missed.

Just came from San Francisco to NY. If you think it's bad here...walk around downtown SF sometime ;-)

You should never meet your heroes (IRL or online). It invariably leads to disappointment.

I wasn't disappointed by meeting DHH. In fact, it led me to respect him even more.

Having senses of humor, they are clearly JOKING with these lines.

Warning: Prolonged exposure to HN comment sections may blunt your sense of humor, too.

Both of them have some insights worth pondering, but the attacks are kinda negatively overshadowing the discussion. Joel really shouldn't have started the Chicago hyperbole.

Do they have some history or it's just impulsive?

I think it all started with Joel's "Language Wars" article http://www.joelonsoftware.com/items/2006/09/01.html for which DHH responded with "Fear, Uncertain, and Doubt by Joel Spolsky" http://www.loudthinking.com/arc/000596.html. They have been at loggerheads since then.

If you're like me and can't access loudthinking link, here's a copy: http://www.artima.com/forums/flat.jsp?forum=123&thread=1...

Thanks for the link. I couldn't really access the loudthinking link.

On this one, I am with David. Joel pretty much negates his point about using something battle tested and mainstream in the end when he mentions using some proprietary language for his product, which translates to a couple of mainstream languages. I don't really see the point of cross-compiling to multiple languages. The work and time invested in maintaining the proprietary language can be better invested on other critical activities. If language interoperability is an issue, thrift or message queues is there to the rescue.

Why he would use some fancy stuff when he himself is advocating using mainstream stuff is beyond me. I sure would be betting on ruby being more robust than whatever he is using in-house (preposterous claim; I have no ideas what they have in-house)

IMO the only valid complain about Ruby was lack of good unicode support at the time post was written.

Did joel ever post a response?

They are competitors.

That alone shouldn't be reason enough and I would say both of them behaved very unreasonably if being competitors is all there is to it. I was asking more along the lines of previous altercations or confrontations.

I do remember some post from 37 signals commenting about Joel's taking investment; not sure if it was David or someone else though.

A very thin line divides frank and honest speech and rude and arrogant statements. Most of the internet celebs sit on the fence and cross it every now and then - Linus Torvalds (Open BSD devs are a bunch of masturbating monkeys), Zed Shaw(Rails is a ghetto) etc etc.

That being said, there always is a take-away as these people are one of the most hardworking and talented people in the industry but the sad thing is it makes it difficult for people not familiar with their style to neglect the firework and just consume the good parts(not that it would matter to any of them).

Joel really shouldn't have started the Chicago hyperbole

He's a New Yorker, it's in his DNA.

The fact that they responded to your jest in sincerity gives hope to the "little guy"

HackerNews: battlebots for geeks who can't build an ashtray without a makerbot

You should take a chill-pill and go check out reddit sometimes.

Agreed, kind of depressing that neither appears to have anything better to do.

Not really. They are both professional writers of online publications. This forum is the perfect place for them to stir up controversy to entertain their target audience. I'm entertained, at least.

I was impressed (surprised?) at how civil this response was. Probably because it was a response to Joel and not randomHNuser9 :)

I was also surprised that it didn't really address the question of whether or not you (37S, dhh) are "stewing in their own witty ideas, listening only to the adoring comments they get from the groupies"

Do you have any thoughts on the "bubble-ness" of Chicago. Think it's a totally invalid point?

Given employees of small service companies sometimes deal with clients more often than they deal with their own families, it's not unreasonable to posit these clients act as a "bubble" that insulates the company from the world at large.

What's laughable is Joel's implicit assumption that the majority of 37s clients are, apparently, Chicagoans. How charmingly pre-internet of him.

Such arguments should be left to professors of financial theory. Here's a balanced analysis:

  In the real world, markets cannot be absolutely efficient or wholly 
  inefficient. It might be reasonable to see markets as essentially a 
  mixture of both, wherein daily decisions and events cannot always be 
  reflected immediately into a market. If all participants were to believe 
  that the market is efficient, no one would seek extraordinary profits, 
  which is the force that keeps the wheels of the market turning.

  In the age of information technology (IT), however, markets all over the 
  world are gaining greater efficiency. IT allows for a more effective, 
  faster means to disseminate information, and electronic trading allows 
  for prices to adjust more quickly to news entering the market. However, 
  while the pace at which we receive information and make transactions 
  quickens, IT also restricts the time it takes to verify the information 
  used to make a trade. Thus, IT may inadvertently result in less 
  efficiency if the quality of the information we use no longer allows us 
  to make profit-generating decisions.
Source: http://www.investopedia.com/articles/02/101502.asp

If you take #3 to its logical conclusion, any company's shares, if sold all sold at once, would be worth far less than the price at the nexus of supply and demand (the market price).

Price is simply a function of supply and demand. It's not customary to use a fire sale price as the sole basis of a company's valuation.


I can verify point five. New York does indeed smell.

only when you're outside. :)

Or not on the subway.

Everyone thinks their sh*t don't stink. Honestly, Chicago smells too.

Yes, like chocolate!

David's point 2 is a good one. It is the reason why bourses insist that a large percentage (IIRC >25% for the LSE) of share capital is in public hands at all times. (Where "public" means people or organisations not associated with the directors or major shareholder.)

Nonetheless, Joel's post is quite funny.

I'd bet they make a lot more profit than 37signals.

it's "a meanningful metric" not "an meaningful metric". Please spell people. This is not SMS!

I think it is always wrong to point out spelling mistakes, except in posts about spelling mistakes.

Especially as many spelling mistakes are actually typos.

Also, "meanningful" is an excellent example of Muphry's Law.


"Secondly, EVERY SINGLE COMPANY IN THE WORLD that has shares that trade is valued by taking the last share traded and multiplied by the number of shares outstanding. It's just the DEFINITION of valuation. It's TAUTOLOGICAL."

Indeed. And Pets.com was worth $100 million on the day of its IPO. And tulip bulbs were worth more than a man's annual salary in 1637. And that house down the street was worth a million dollars last year. Someone paid for those, too.

You don't have to have a different definition of "valuation" to see that a small sample of the most eager investors in the private market doesn't guarantee a reliable estimate of value.

Value is determined by what someone- anyone- will pay for something. And it makes sense if you think about it. The goal is to find out how much you can sell that something for and it is the exact same problem as figuring out how much someone will pay for that something.

Company valuations are messier than tulip bulb valuations though. With tulip bulb valuations you are saying that since someone will pay x the bulb is valued at x. With company valuations you are saying that since someone will buy 1/n of the company for x then the company is worth n*x. This makes sense because people really want a piece of facebook and valuations do a great job of setting that price. But the price is also used to determine how much the entire company will go for, which is how the number is often thought of.

As long as the valuation goes up and you have the opportunity to sell for a net gain then it is a good investment. DHH's thoughts here are important beacause they call attention to a valuation bubble. I think the main controversy lies in his creative use of words.

> Value is determined by what someone- anyone- will pay for something.

Not "someone", but THE MARKET ... when you buy a piece of Facebook, but won't be able to sell at least at the same price, then you're the loser ;)

When multiple losers gather and start buying stupid shit with no value to THE MARKET, that's called a BUBBLE, that will burst sooner or later.

The trick for estimating if "the valuation goes up" is to see if that company actually provides value (i.e. actual profits, since that's the only goal of a company) ... and in that light, DHH's opinion makes a lot of sense.

I dont disagree with anything you or dhh said although I don't know for sure if his predictions will hold.

Right. But unless you think there's someone (or a set of someones) who would pay 33B for all of Facebook, it's not unreasonable to assert that it's not worth that much.

Agreed. We are valuing the whole pie based on the cost of a slice, which is problematic for many reasons...

Value is determined by what someone- anyone- will pay for something.

This is unexamined Econ 101 dogma. See the other posts on intrinsic value.

I say this coming from a practical point of view though. If I can sell something today for at most 15 bucks, that is how much it is worth, no?

Actually, in my mind price is what anyone will pay for something - the value may not be the same as the price

It should be immediately obvious that they're comparing intrinsic value vs market valuation, so no, it's not tautological at all.

Everyone who invests should know that market value does not necessarily predict intrinsic value, and it becomes more problematic when there's illiquidity, and when only a small fraction of the company is being bought and sold. These are basics, going back to Ben Graham's famous book on value investing, and probably much further back than that.

Even if liquidity and size didn't matter, it's still a basic error to go by last share traded and claim that that represents the actual value of the company.

Exactly. While the technical sense of valuation might be tautological, it's also nowhere near the average person's definition of economic "value" or "worth". A good test in the every-day sense of those words might be if company X were given 3 months to sell off everything and end up with a stack of cash, how much would they have? Apple could stand a chance of getting reasonably near their valuation whereas I'd be shocked if Facebook could.

    Is the problem that they're sitting there in a city 
    without any other Internet industry
orbitz, groupon, careerbuilder, peapod, everyblock, skinnycorp, grubhub, the onion, ars technica, to name a few

And Google since they bought FeedBurner a few years ago.

their utter and complete misunderstanding of all the basics of business is starting to grate on me

Their linkbait really grates on me as well (though I happen to agree with this post's conclusion, if not the methods), but I think it's pretty unfair to say that they misunderstand all the basics of business. They seem to be doing pretty well for a shop their size. In fact, I'd say there's a good chance they're doing better than Fog Creek. Maybe misunderstanding the absolute perversion of what too often passes for "business basics" in Silicon Valley isn't such a bad thing.

Considering their success, how do they misunderstand the basics of business?

That's my point.

Haha... I just reread your comment. Sorry, I read it too fast the first time.

I don't entirely disagree with your points here, but as someone who is from Chicago and spent many years helping to build a very successful Chicago-based business (Threadless), I take offense to the notion that David's misconceptions have something to do with Chicago.

First of all, he's from Denmark – he just lives in Chicago. Secondly, ever heard of a little startup called Groupon? They're from Chicago and I'm assuming they have a few people there that excel at multiplication.

The location of 37signals has nothing to do with it, and you're clouding an otherwise clear and well articulated set of points with the asinine notion of "no one outside the valley understand business".

37signals is great at understanding the laws of small business, however arguing with those same laws doesn't always work when scale is involved.

This would have been a valid argument 2 years ago if Facebook was trading at this valuation, however Facebook has a reasonable valuation given their rapid revenue growth. They may surpass $200 million this year and their user base is still about to double (yes, to beyond 1 billion users).

They haven't even begun to open up the revenue faucet. 37signals should stick to providing advice to "lean startups" who want to build small businesses.

What if there's not faucet to open?

There is a faucet to open, and a big one at that.

The fact that they have gotten to the point where other companies are able to build majorly successful (Zynga) businesses based on their platform, and the fact that they have become ubiquitous with many business' marketing and online presence speaks for its self.

The fact that the total amount of time spent online is greater for those on Facebook than Google (including Youtube) is also important. http://news.cnet.com/8301-1023_3-20016046-93.html

But what is more important is Facebook's pursuit of pushing the envelope and being willing to innovate and lead as the online landscape changes.

The posts above which mentions that people were saying the same thing about MySpace having the user base and then not being able to monetize is like comparing apples to rotten tomatoes. MySpace was not a technology company, Facebook is. MySpace was primarily a media company with little to offer technologically (see: http://paulgraham.com/yahoo.html), Facebook is building a social web that has deep horizontal integration with the Social Graph Protocol, mobile communication, and is actively trying to optimize it's infrastructure for both scalability and user experience. Look as far back to their decision to go with AJAX and not base everything strictly on page loads (as MySpace did), or as recent as their open sourced internal projects... (I don't think MySpace ever worked on any HipHop PHP or Cassandra)

Facebook is in it with the right mindset, to be the leader and game changer in the "social web," and with both the value and quantity of data they are constantly amassing I wouldn't be surprised to see them on par with Google in a few years.

Also, as they grow they can continue to optimize and decrease costs on their end... I'd say they have both a big faucet to open and probably a few leaks they could plug as well, the combination of which makes for a large valuation to be expected.

It's always easier to look at something we don't quite fully understand from the outside (not many people understood the true value of those little text ads on Google until later) and then make blanket assumptions on valuations based on other companies that were inflated but not even on the same playing field as the company being discussed.

Seriously, Joel, Facebook just needs to "optimize" a bit and they'll be more profitable? Really? With a valuation of $33 billion, Facebook needs to make a bit more than a dime or two extra from their users. They need a ton of real dollars from each and every user or (more likely) dozens or hundreds of dollars from some users and nothing from the rest. How are they going to do that, exactly?

How will Facebook change its platform to convert its hundreds of millions of users, who signed up for a free party, into billions of dollars per year without spoiling the party? No one likes getting invited to a party with their friends only to find that the beer isn't free after 11:30, or worse, they've been tricked into attending an MLM meeting. If Facebook could convert eyeballs to dollars the way Google can, there was no reason not to do so when they had 50 million users, or 100 million, or 200 million... It hasn't been done, though, because it would spoil the party and stop that lovely flow of VC money.

I am just gobsmacked that, within just a few years of the US housing market bubble popping and the financial empires getting caught with their pants down, you would continue to support the speculators' fantasy of pre-IPO tech valuations. These types of valuations aren't just irresponsible or insane, they're scams! The consumers have no money or credit left, so the easy money is going to come from gullible investors.

There is a relevant difference between valuations derived from secondary markets and public markets. Investors in secondary markets rarely have clear understanding of real financials or the capital structure of the company. This is a good writeup: http://www.homethinking.com/brontemedia/2010/09/17/secondary...

Also, Chicago has lots of smart people, and I agree with you that FB is well positioned to make lots of money.

What does Chicago have to do with FB valuation? KTHX. DHH makes a good point though - what are FB's profits/profit projections? No one knows. Assuming its $200M, how the hell can FB be worth $33B? That's all...

It could well be that "only" $200M in profits is the result of spending $$$ on R&D and product development (FB Questions, FB Places, FB Credits), which could lead to a massive amount of cash flowing in shortly.

They've massively invested in infrastructure, which has certainly lowered profits. They could very well start benefiting from this as soon as next year.

Without information, though, it's all speculation.

Without information, though, it's all speculation

Right - that's the point. The valuations are not based on actual profits or profit potentials but rather on speculation/hype, which means bubble, and when a bubble bursts, it ends up hurting the entire community.

Obviously, startup valuation is not a science. BUT when valuations are based on wild projections (such as FB will be be more profitable than Google), then someone must call it out.

I agree mostly, but it is true that in private equity, it's not always taken for granted that you can take a small stake's buy-in price and multiply it out to get a valuation. It depends on why that investor bought in, what the prospects for similar investors are, etc. It's taken with much bigger grains of salt than the standard (share price * shares outstanding) valuation for public companies is, anyway.

Last I checked one of the most profitable "internet" businesses (Groupon) in the last decade is in, and founded in, Chicago.

A dime per user is nice and all, but they need to make 20x that for a billion dollars in revenue. That's still only $2 per user, but a lot harder.

My gut feeling is that Facebook is somewhat overvalued at $33billion. (This is $66 for their average user.) But I don't think it is overvalued by orders of magnitudes and I think the 37signals article is very demagogue.

People are horrible at taking variables like growth into account.

It isn't 66$ per user. It is 33billion/expected number of total users over the lifetime of facebook.

So if you throw in rough estimates of 2 billion facebook users and give them a decade of profiting from an average user...3$ per year per user.

Which means that if Facebook's valuation rises over the next decade there will be an even bigger gap between their user base * revenue per user than there is today. Either that or their valuation will have to remain flat for the next decade.

Does anybody else see a problem in that?

A company's valuation can certainly take into account growth potential, but when it assumes massive growth and leaves no margin bad things happen. Risk is much higher since any faltering of the company would need to be adjusted for in stock price almost instantly. If a normal company sees slower than expected growth the stock may fall a little. If an overenthusiatically future valued company sees slower than expected growth the stock may tumble by huge margins (because it's tied to the company's size 10 years from now, not today). Worse yet, if there's no margin remaining in stock price it'll be forced to remain stagnant for a very long time. This is bad for investors and bad for the company (because the use of stock as employee compensation is less potent).

It strikes me as a bad plan to depend on 400% growth that's sustainable over a decade. You're right, people are horrible at taking growth variables into account. They usually overestimate them.

Facebook may well achieve the numbers outlined above. But let's not kid ourselves. People were doing the same back of the envelope calculations for MySpace when it first started to get big. I see nothing wrong with a judicious use of common sense and caution in this case.

Things are changing very fast in this industry. So even 10 years and 2 billion users are optimistic numbers. And if you take 2 billion users, most of these users are from very poor countries, it is extremely hard to monetize these users (almost orders of magnitudes harder than users from rich countries.). That said, I don't think that Facebook is overvalued by orders of magnitudes, and the 37signals article did not make much sense to me.

2 billion active users is almost 1/3 of the worlds population. That seems like a strech.

Also you can't link the 33billion to expected. 33billion is their "valuation" now with 500M active users. There's a certain expectation that your valuation should go up as users increase.

Personally I think the per-user deal is kind of a red-herring. Revenues and Profits are the only things that really matter. Users are just a one (good) dataset for estimating growth - but hardly the only one.

"rough estimates of 2 billion facebook users"

Right. Because the Chinese and Indian Peasantry is definitely going to be on FB.

Not to mention other platforms are more popular in other countries. For example, Google's Orkut is very popular in Brazil and I'm sure Baidu et al are working on offerings for the Chinese market. USA != world

They're almost certainly making $2 per user. Another dime is gonna be easy.

First of all, Joel, it's THEY'RE not THERE. ;)

Hey, lay off man! If Chicago doesn't have to teach multiplication, New York doesn't have to teach grammar, alright?

Read the original post, Joel didn't make that mistake.

lol, he edited it.

Haven't got a dime from me, and they don't have an idea on how to.

Also a dime per user/year is more than it seems when you can only collect it through indirect means (ads, charging other companies for using your platform). Remember their ~500mio user figure also includes the overwhelming portion of users who generate no more than a handful of page impressions per month.

It's not like facebook could invent a yearly membership fee or start selling t-shirts or such...

Well, they could, but I doubt more than ~20% of their audience would actually pay.

They'd be lucky if ~0.5% of their audience would actually pay.

You don't think so, but they probably have.

I always used to think I was a 'leech' user of TripAdvisor, until I worked there.

Have you viewed more than 300 pages on the facebook.com domain in your lifetime?

If so, they've gotten a dime from you.

3 ads per page, each ad selling at a $0.10 CPM.

I think their CPM is in the $30-$40 range, but the key missing piece of information is how many views they get per user. I know my Facebook use has gone from multiple views per day (20, 40?) to 1 page every other day. Still lets say each user looks at Facebook twicer per day, each user is about 1/2 a CPM per year, or $20 revenue per year.

But CPC, well I've never clicked on an ad on Facebook in my entire life.

Never use tech-savvy people as representative examples when evaluating advertising.

Otherwise, even google would be out of business.

The problem with the comparison of Facebook VS Google is that Google advertising is fantastically targeted.

You literally type into Google "I have this problem" and get a bunch of ads solving that problem. It is practically the holy grail of advertising. Now consider that it is a catch all for personal and corporate questions, it is a cash cow. It is perfectly acceptable to google something at your job, click on a link, and buy a $15,000 system.

Facebook might know a lot about you, but they don't know what you are looking for at any given moment. Add on top that most people are spending their time on personal relationships, and it isn't the same even if they get more impressions. I can't log into Facebook from work and say "who has 5" diameter pipe?" and expect a response, but if I google that I find a vendor and place a multi thousand dollar order.

Also the market on Facebook is somewhat inverted. The "best" customers are generally on their the least. The most frequent people are college students - mostly broke at that. If you aren't advertising clothes, personal electronics, or local bars I don't see the draw.

Speaking as someone who has spent $30,000 on Facebook ads in the last several months: Facebook advertising is fantastically targeted as well.

Google ads work when there is so-called "purchase intent": I know I want a new waffle maker, so I search for it.

Facebook ads work when there is demographic correlation: I just got engaged, and I might not know that I now need a waffle maker, but a Facebook ad can target me and tell me that I should be adding a waffle maker to my wedding registry.

Different kids of targeting, both extremely powerful.

So you're the one putting all those wedding ads on my Facebook page. I hate you.

Congratulations on your engagement!

And seriously. Waffle maker. It's the gift that keeps on giving.

you must be kidding, right? If their CPM were $30-40 they'd be making many billions per year, not (maybe) 1 billion.

I'm not sure a company doing as well as 37s can be accused of having a "complete misunderstanding of all the basics of business".

On behalf of

Groupon.com Orbitz.com Feedburner.com CareerBuilder.com TicketsNow.com Peapod.com Apartments.com Restaurant.com ShopLocal.com Legacy.com GrubHub.com EveryBlock.com Apoolicious.com Threadless.com Newser.com Songza.com ViewPoints.com Timelines.com SitterCity.com BlockShopper.com CarePages.com SurePayroll.com OneWed.com

...and many other Chicago-based internet companies

Fuck off.

You forgot cars.com, viewpoints.com, and navteq ;) Clearly no internet here. Oh...and no financial companies either (I wont start a list of the many)

The present valuation isn't as important as intrinsic value if you're talking about the long term. Of course the valuation is a multiple of its trading price. With that definition, its worth whatever people are trading shares think its worth. But that's only 3% of the shares.

But what I think the 37signals post is addressing is how directly tied this valuation is (or isn't) to the company's intrinsic value. price-to-earnings, a guess at its margins, durable competitive advantage etc etc. In that sense, is facebook truely worth $33B? That's a different question than what's its current valuation. Its subjective, to be sure, but its still fundamentally different.

Its a private company. I doubt many outside the company know its financials. Information scarcity leads to pricing inefficiency. For all we know, speculators might be driving up the price to cash out sooner.

Another point I mentioned before: Everyone is incentivised to see the valuations go higher. The VC's, employees with shares, the founding team, etc. They can cherry pick talent from the competition with such valuations. Since I don't think you can short SecondMarket stock, there's no way to bring negative information into the market to keep prices rational.

To your last point, facebook has certainly figured out how to make money off its current users. But it has radically changed the underlying user-conventions to get there. It started out as a college-yearbook and photo storing site with no profit-motive. In order to become profitable, its iterated on that simple concept with such a pace that the majority of users have yet to catch on with how things have changed beyond photosharing and posting on friends walls. The majority of people have no idea what is being tracked. For them to squeeze out further revenue, it follows that more fundamental changes must take place to get there.

Whats one thing that could absolutely destroy facebook? Overnight? If they started making public which users were viewing which profiles, and with what frequency. That could kill it pretty easily, I think. Of course, they would never do it, but I think if a terrible scandal or crime occurs, involving sensitive user data, and people are compromised in such a manner, that would be a problem for facebook.A billion dollar company shouldn't be so easy to kill.

The Chicago dig seems really, really unnecessary.

It's as valid as when people refer to the Valley as one big techie circle-jerk. Or as the most fertile technological environment in the world. Location, location, location.

37signals != Chicago


> "The city posted a sign," means that an employee of the local government (but not the geographic location or all of its residents) posted a sign

I remember a documentary on Walmart where someone said they succeeded by realizing that a small percentage from a very large number is still a very large number.

Joe Walton wrote a book about it.



I think you are talking past one another. He's saying that he does not think that their valuation is merited. You are saying that his assertion makes no sense because valuation is, by it's nature, defined by the current trading price.

You are I think technically correct, but the market isn't always perfect in judging the value of something, and I think he is saying that this is one of those cases.

"The whole section "Minority investment evaluations aren’t real" is so economically bizarre and incorrect that I don't even know where to start."

I don't think that's so bizarre to say. If there is huge demand for something and only a very very limited supply, then doesn't it stand to reason that price will go up more than it would have otherwise if there was more supply?

Secondly, EVERY SINGLE COMPANY IN THE WORLD that has shares that trade is valued by taking the last share traded and multiplying by the number of shares outstanding. It's just the DEFINITION of valuation

Facebook is not (yet) public, which is a massive factor relative to the calculation of its book valuation. Presumably, at least on the surface, all of this facebook hype of late would indicate that what used to be a closely-held entity is quickly becoming ripe for the IPO market. What the actual valuation is (or will be) cannot be determined until the free market goes to work on it.

But then again, speculation, anticipation, and fear . . . these have all been attributed to major market fluctuations, crashes, overnight millionaires . . .

Given fb's current position - would it not be incredibly stupid to NOT do everything possible to continue their growth and try to become more widespread as a necessary layer of the internet?

Assume they want to continue growing. Growing both the number of total users and the number of places they grab the users' attention (mobile is the next natural play). Of course they would continue raising money and not worry about profit margins right now as they are still driving money back into the company's growth.

There are two factors that influence your 'multiplier theory' given their advertising model. Number of users and the amount of attention you have from those users. They still have a lot of potential upward growth in both areas.

If facebook made a billionish dollars this year on ad revenue - they could double it with twice as many users. Double it again with twice as much user attention from being a core part of the mobile web. They are still growing their ad platform, so that is another multiplier.

Of course doubling their user base twice is something like 30% of the human species. I'm not sure that's realistic.

Of course Facebook is not worth $33bil. Fact: The Facebook engagement numbers for users suck. The data is inflated. That all is fact BUT forget that. Apple shares cost $6 per dollar of revenue. At the same valuation Facebook is worth $9bil. Would you really pay $25 per dollar of Facebook revenue knowing in 2-3 years they could be the next Myspace? They sell nothing. They are actually the Seinfeld of Networks. No loyalty. Nothing preventing anyone from jumping ship. If you think I am wrong people invested way more in their Myspace experience...photos, blogs, video, tricked out pages etc. And then just left. Gone. Bye. See ya.

Remember a sucker is born every min and Elevation Partners has been a sucker over and over in many investments. Would you spend $6 per dollar of Apple revenue or $25 for a dollar of Facebook? Case closed.

"The cynic knows the price of everything and the value of nothing." -- Oscar Wilde

Disregarding the technical usage of the word valuation in investing, I see three ways of interpreting the terms in the argument here. The price of Facebook is 33B, simply extrapolating from the price of tiny percentages of Facebook.

The value is related to the price people are willing to pay, but is actually unknown and only exists as a prediction of future cash flows.

The worth is a more nebulous concept and related to how much Facebook improves the world.

It seems like spolsky is talking about the price, and dhh is talking about the value, and making illusions to the worth.

y so serious?

-The last executed price times shares outstanding is market cap. Valuation is dcf or guideline; there's a big difference between capitalization and valuation.

-Sharespost can not be considered liquid as all of its securities are governed purely by regulation D and are by definition on hard to borrow

-Facebook will not continue its current exponential rate of revenue growth for the standard 5 year assumption DCF

(jk, but maybe not) Its most avid core user base will graduate with their faggy liberal arts degrees, find out they can't earn for shit, advertising revenues will peak and decline, at which point Facebook will file a timely SEC S-1, followed by a record oversubscribed ipo mostly bought by parent(sponsors) of said faggy liberal arts graduates, then get basket shorted down to 50% of offering price. IB, instl. trading desks, and VC will already have gotten rich long before this; everyone else loses. Same deal with carbon/ECX emissions futures.

-NY owns Chicago; Chicago is the guy on the merc floor shouting hundreds of open outcry bids while one trading desk at 200 west st. takes every bet against him using one single macro on Rediplus. (jk, respect to all veteran floor traders)

-I'm sure everyone will decide their bets based on their own risk-reward/due diligence anyways. Nothing we say to each other will have a huge effect; in the end, the bids and offers we provide will do all the talking for us. That's why the market exists so let the games begin.

The only correction is that in this phrase "Facebook works on the theory that when you have a lot of people, you don't have to make as much per person, because the amount of money you make is the number of customers times the amount of money you make off of each one" you confuse customers and users. Facebook users are not their customers. The customers are advertisers, and there ain't 500m of them. So, although their profit hugely depends on the number of users, it's not the only component in the formula.

Users who aren't spending (at the moment) are better termed "product" since their presence on the site is being sold to others.

Actually Joel, your assertion that dhh simply needs to look up valuation in the dictionary is absurd. Valuation is not neatly defined. It's hugely subjective -- especially for private companies.

>It's like you wrote a blog post arguing that it is >incorrect to refer to a 5' tall boy as 5' tall because >he's often sitting down.

It's not like that at all. It's more like comparing a 5' tall boy with a 5' tall light pole and deciding that valuation is based on height alone.

>It's weird, it's like in Chicago they don't have multiplication or something.

Yeah, good point.


Sure, but I would hardly call secondary markets for startup shares a valid market or even try to compare it to public market. Come on, Joel!

So you would agree with the valuation of Slide or Ning a few years ago? Maybe. Would you now? No. Valuation of private companies is not a science but an art. That's startup 101 stuff. Do you really call Sharepost a market most investors would call credible? Please.

There are numerous methodologies for valuation. "last share traded" is by no means the ONLY method. Markets by definition are made up of actors who independently value commodities in various ways, none of which are definitively the only valuation method. Is that tautological enough for you?

Perhaps a little more humble thoughtfulness, rather than indignant ignorance, would do you some good.

Perhaps it is more correct to say that the potential revenues from this thing don't justify the valuation. It wouldn't be the first company to be overvalued and the fact that many owners of this stock cannot sell is certainly relevant.

Here's my issue after reading all of this. Who the hell cares? I love minutiae as much as anyone, but this is worse than arguing about text editors.

This sounds like a bunch of privileged people arguing about something that that doesn't make a damn bit of difference to what's really needed in this world.

I thought I was going to learn something. But now I just feel a little ashamed that I read any of it all.

"Is the problem that they're sitting there in a city without any other Internet industry, stewing in their own witty ideas, listening only to the adoring comments they get from the groupies?"

As opposed to being located in a circle-jerk of similar minded companies and VCs, responsible for the first internet boom?

"The whole section "Minority investment evaluations aren’t real" is so economically bizarre and incorrect that I don't even know where to start. It's like you wrote a blog post arguing that it is incorrect to refer to a 5' tall boy as 5' tall because he's often sitting down."

If he's ALWAYS sitting down, then it's accurate to argue he's not really 5' tall ―not for any practical purpose, that is.

But not only "minority valuations" are not real, but majority valuations are not real either. Valuations are based on guesses, feelings, estimations and some facts thrown in for good measure. A declaration of fact, they are not. Some time they are even complete BS.

"Finally, to the main point. Facebook has certainly figured out how to make money off of 500,000,000 users. And as they optimize, they will make a lot more money. When they figure out how to make another DIME off of every user, they will instantly be making another $50,000,000 a year... in pure profit. How much profit will 37signals make if you figure out how to make another dime off of every customer? Eh David?"

And how useful is David's products to customers, eh Joel? How possible it is that they jump ship en masse when something trendier comes along, compared to Facebook? That is, which business is based on a solid offering, and which on virtual smoke and manure?

Yahoo could once milk 500,000,000 users too. Nowadays, not so much.

"Facebook works on the theory that when you have a lot of people, you don't have to make as much per person, because the amount of money you make is the number of customers times the amount of money you make off of each one. Again, that pesky multiplication."

Yes, many a business failure was based on that theory. It's the old, "we lose money on each product, but we'll make it up on volume" idea, adjusted as "we make a tiny fraction of money from each user, providing no real benefit or substance, and he can jump ship tomorrow like he did on several of our predecessors, from Frienster to MySpace, but we'll make it up on volume".

"It's weird, it's like in Chicago they don't have multiplication or something."

Most likely it's like NY has no manners...

But the real question is, should someone even partially responsible for Visual Basic even be allowed to talk about tech?

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