Before turning on the water

12.21

2009

Post By:
Ryan Graves
Category:
Economics, Entrepreneurship
Tags:
Twitter, valuations, Venture Capital
Comments

Post Info

159712017_ddba7496ca

Quick thoughts on big valuations from pre rev startups:

There are a lot of folks that don’t understand why Twitter or other startups like them can be valued at such enormous valuations while showing minimal or zero revenues. I respect your skepticism. It’s tough to understand why these early stage start ups have millions of users but aren’t profitable. Please understand that most of them could create revenues if they wanted to, but just turning on the revenue spout isn’t most important. Turning on the revenue spout when all the pieces are connected properly is critical. I’d like to use this analogy to explain this further.

If your connecting a hose to the spout/spigot and you turn on the water prior to ensuring you have the hose connected properly, you’re going to have a mess on your hands, everyone’s getting wet and the process of watering your grass and using the hose is a failure. However, if you ensure a proper connection from spout, to hose, to sprinkler, you’re going to have a great experience, the grass get’s water and growth occurs.

These companies have already proven that they know how to acquire users, the water is running, now it’s a matter of connecting the pieces properly before they turn it on so that the combination of water (users), hose (business model), and sprinkler (team) are all connected properly to maximize their revenue opportunities.

Excuse errors, first post from my iPhone. (Update: added photo)

Update: Twitter is reported to be profitable after making search agreements

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allenburt

I'm personally skeptical only when the revenue model has not been defined. I agree, the connections must be joined together tightly before turning on the water. But, many of these high valuation startups have not (at least publicly) defined what type of hose (rev model) they are going to use.

Users x Great Revenue Model = High Valuation. I have a hard time swallowing a high valuation without a clear understanding of HOW they will make money.

Ryan Graves

Trust me, these startups are contemplating revenue model opportunities from
day 1. It's rarely public however, and this privacy of plan strategy
significantly benefits them from a competition perspective.

Publicizing their rev plan may benefit some startups in this way: As an
example, if twitter plans to charge for use of it's API (which I doubt they
do) then they should be clear with that up front so that they don't piss off
thousands of developers down the road. Don't lock people in then turn on the
"you have to pay us now" switch, that could be dangerous.

allenburt

Startup valuations are by their very nature skeptical.

Most web technology startups are extremely difficult to value because nothing like them has ever been done before. These valuations are based on nothing more than what a few seed investors believe them to be worth. There is no such things as market comparables or cash flow to base value.

Sure, you can estimate market value based on what others have invested for pieces of the business (ex seed funding). But these investments are extremely high risk, well above normal failure rates. Therefore, not very good indicators of long term expected value.

You better be skeptical of startup valuations.

Ryan Graves

Thus my comment, "I respect your skepticism."

:)

reecepacheco

Great analogy.

I was a volunteer firefighter for a bit. You always lay your hose, check your connections AND be sure you're holding on tight, before letting the water go.

When you don't, it's a disaster.