Hello and welcome back to our regular morning look at private companies, public markets and the gray space in between.
There’s a famous old post going around Twitter this week by entrepreneur and developer David Heinemeier Hansson (@DHH). DHH is a critic of certain elements of the startup world, especially wild valuations. This entry from him is, in my view, a classic of the genre.
The post in question is titled “Facebook is not worth $33,000,000,000,” and was written back in 2010.
You can already imagine who might find the post irksome — namely folks who are in the business of putting capital into high-growth companies. This sort of snark, though not precisely recent, is a good example of how posts like the Facebook entry are read on Twitter.
If you take a moment to actually read DHH’s blog, however, you’ll find that the first part of his argument is that selling a minute slice of a company at a high price, thus “revaluing” the company at a new, stratospheric valuation, is a little silly. DHH didn’t like that by selling a few percentage points of itself, Facebook’s worth was pegged at $33 billion. We’ve seen some similarly-small-dollar, high-valuation rounds recently that could be scooted into the same bucket.
It’s a somewhat fair point.
But what struck me this morning while re-reading the DHH piece was that his second two points are useful rubrics for framing the modern, post-unicorn era. DHH wrote that profits matter, companies are ultimately valued on them, and that companies that don’t scale financial results as they add customers (or users) aren’t great.
All of the arguments work. Indeed, the most valuable tech companies in the world are massively profitable. And they have consistently become more profitable as they’ve added customers.
These arguments hold together when it comes to recent negative examples as well, in fact. Let’s compare the points he made in the blog post against a number of modern unicorns that saw valuations skyrocket based off small (or shrinking) equity sales, didn’t make money and were unable to scale good financial results after adding customers. Our cohort of examples have each struggled in recent quarters, which underscores what DHH was trying to argue, at least in my reading.
We’ll start with with WeWork and then drag OYO and Airbnb into the mix. We’ll wrap with Uber.
The implied point of what follows is that going public is a great way to determine the value of a company: Its performance becomes public knowledge. Its shares trade every day. In contrast, when information is opaque and trades infrequent, you get distortions. So, more companies should go public.
Beware (some) mega-unicorn paper valuations.
WeWork’s (short-lived)
DHH’s warnings about small-share sales leading to huge paper valuations look a bit off-kilter in the case of Facebook, as the company wound up generating huge profits and became worth hundreds of billions of dollars. But as we can see in a number of recent examples, his general point was pretty good.
Remember in January 2019 when WeWork raised $1 billion at a $47 billion post-money valuation? In that transaction, a little more than 2% of WeWork’s equity was sold, but the company’s valuation rose by billions. A 2018 investment worth $3 billion was another example of a single-digit percentage of the company’s equity trade hands for a multi-billion dollar valuation gain.
Both the early-2019 $1 billion deal and the company’s $3 billion late-2018 infusion valued the company at over $40 billion. Those rounds were executed a price that was more than double what the company raised at in 2017 when it sold $4.4 billion worth of equity at a $20 billion post-money valuation. The 2017 investment was a bit more reasonable, in that the investor (SoftBank’s Vision Fund) bought more than a fifth of the company.
As the rounds got smaller in equity-percentage terms and the valuation shot higher, WeWork ascended until it got too close to the sun before falling back to Earth.
According to SoftBank’s latest earnings, WeWork is now worth less than $3 billion.
Putting WeWork up against DHH’s three rules from his Facebook blog post, let’s see how things go:
- “Minority investment valuations aren’t real?” Yep.
- “You’re only worth something if you can make money to keep?” Yep.
- “No outrageous profits after seven years and half a billion users?” A little different, but WeWork managed to lose more money the more customers it had, so this fits as well.
There are other examples from the late-unicorn era that are worth considering.
OYO, Airbnb, Uber
OYO’s story features slightly less ludicrous valuation gains off the back of decreasing-percentage-of-equity deals than WeWork, but its story feels similar. Here’s some of its funding history:
- September, 2017: OYO raises $250 million at an $850 million post-money valuation (29.4% of the company sold)
- September, 2018: OYO raises $1 billion at a $5 billion post-money valuation (20% of the company sold)
- December, 2019: OYO raises $1.5 billion at a $10 billion post-money valuation (15% of the company sold)
The percent of the business sold fell each time, even as the amount of capital going in went up. What happened next? A Pandora’s box of issues, including operational and financial woes that were exacerbated when COVID-19 hit.
Returning to DHH’s rubric, what do we have? Increasingly small investments boosting OYO’s valuation? Yep. Not making money? Yep. Not performing better financially as it scaled use? Yep.
Let’s be quick with Airbnb as this entry is running a little long. In 2015, Airbnb sold $1.5 billion of stock in itself at a $25.5 billion post-money valuation. Therefore, it sold around 5.9% of its shares to value itself at more than double the $10 billion valuation it set in 2014 when it sold about 4.8% of its shares.
A 2017 Series F worth around half a billion dollars pushed the firm’s valuation over $30 billion. Small-fry investors did that one better, buying up Airbnb shares at a valuation of more than $40 billion.
Then Airbnb missed is IPO window, started to lose money and ran into a pandemic. Tiny-share sales wound up valuing Airbnb at a price that it could not support and now the startup is shedding staff, seeing falling revenue, and more. Airbnb, unlike OYO, is a pretty solid company in that it has a history of profits, but it still fails the DHH tests.
Finally, Uber, which sold around a half billion in stock to Toyota in late 2018 at a $72 billion valuation, post-money. It’s now worth more than a dozen billion dollars less. This is another example of a tiny round setting a higher “price” at a company that loses money, and doesn’t scale income as it adds customers.
DHH strikes again.
Some of these companies may recover and excel. If so, you might look back at this post and try to make me feel bad. You won’t succeed. The market may have become inured to “repricing” unicorns at higher and higher valuations as smaller and smaller stakes are sold at increasingly rich prices. But that’s not the same thing as going public and actually having the market price the company. And to have the public market give you a similarly high valuation will, in the long-term, require profits.
That is as true today (as we’ve seen) as it was back when DHH wrote his blog.