Once upon a time in Silicon Valley, a billion dollars was a big deal. These days, companies can catch multi-billion-dollar valuations on the fly. Take, for instance, the big numbers bandied about this week. Investors are waving term sheets at Snapchat for $500 million in financing under the assumption that the app is worth $19 billion. Pinterest is also in the process of raising $500 million, but at a more modest $11 billion valuation. "Facing overwhelming demand" from investors, Uber agreed to accept an additional billion dollars in financing, just a few weeks after the e-hailing app closed a $1.2 billion funding round that valued the company at $40 billion.
Fortune and The Wall Street Journal have both illustrated the growing number of startups that investors think are worth $1 billion. (Companies that have crossed that threshold are called "unicorns." It's a term used mainly by insiders, but it helps illustrate this age of magical thinking.) To put the recent fervor in perspective, it also helps to see how rapidly these multi-billion-dollar valuations have multiplied. We created a graph (below) using data from CB Insights, a venture capital analytics company, to chart seven of the fastest-growing and most promising (if unprofitable) among them. You can click on the dots or on the company names to filter.
A quick note on how profitability relates to valuations: it doesn't! At least not yet. A source told The Verge that Pinterest is seeking an $11 billion valuation even though revenue for 2014 was under $50 million, and projected revenue for 2015 is roughly $200 million. Pinterest declined to comment. Venture capitalist Bill Gurley — an investor in Uber and Snapchat through his firm, Benchmark Capital — once called multiplying revenue a "crude tool" for calculating a startup's valuation.
Instead of using that metric, current VC logic prioritizes fast growth above all else. VC firms are fond of noting that only 30 percent of cellphones used today are smartphones, giving their portfolio companies plenty of room to grow. Plus, there are all those real world industries to try to topple. Build momentum now, figure out how to make money later — otherwise, you'll miss out on the next near-mythic exit. Facebook bought Instagram for $1 billion in 2012 when it had 30 million iOS users, then paid $22 billion for WhatsApp, which had more than 450 million users around the world, just two years later. Investors would much rather get in early than miss out on that kind of stratospheric growth.
If Snapchat, the latest poster child for the massive ballooning of valuations, signs those term sheets, its valuation will have nearly doubled in six months — or three months, depending on whether you look at when news of its latest funding leaked or when the round ended. (For private companies, valuations are typically revealed as part of a funding announcement. The dates on our chart reflect when a funding round closed. You can read more on CB Insight's methodology here.)
Regardless, that’s an awfully short time to go from $10 billion to $19 billion, even if it seems like this tech boom just swapped out the word "million" for "billion." If Snapchat agrees to $19 billion (a figure that even makes CEO Evan Spiegel nervous), it will be the "third-most valuable venture-backed company in the world." And there's reason to think it will come to fruition; no one's saying Spiegel should've taken Facebook's $3 billion offer from 2013 anymore.
The first most valuable company is Xiaomi, which is based in China. The second most valuable venture capital vacuum is Uber. Last June, the e-hailing app was valued at $17 billion. Six months later, investors decided it was worth $40 billion. A similar dynamic explains why Pinterest can say it will use that $500 million to do things like expand in Europe and Asia and "develop a business model" later.
Why is there such a focus on a handful of companies when Fortune recently identified 80 "unicorns" galloping around with $1 billion stamped on their hides? Because the surge in venture capital is fueled by bets on a few pretty, pretty ponies. According to CB Insights, VC investment in internet companies expanded to $19.6 billion in 2014, driven by "mega-financings to a small but growing group." That's why the amount of funding was up 67 percent year over year, while the deal activity for 2014 was up by only 7 percent.
How did we get here?
One major factor in these super-sized startups is the reluctance to go public, if they go public at all. Silicon Valley investor Marc Andreessen blamed regulatory changes that make it harder and more expensive to file for an IPO. Fusion points out that the rule forcing startups to go public once they hit 500 shareholders no longer applies. Uber CEO Travis Kalanick wants to "grow in the private markets instead of cashing out Pets.com-style," says Fusion, because he can.
Now that the fun is happening in the private markets, the multi-billion bonanza has attracted players outside Silicon Valley. Last April, Andreessen cautioned startups against accepting over-sized valuations from out-of-towners. But it doesn't seem like founders heard his tweets.
Snapchat raised a $50 million Series C from the New York-based hedge fund Coatue Management. Fidelity Investments, the mutual fund and financial services group from Boston, participated in Pinterest's past two rounds of funding. Airbnb’s $475 million Series D included T. Rowe Price, the massive global asset manager based in Boston.
Mutual fund manager Wellington Management, also based in Boston, is diving into the pre-IPO end of the pool. Uber’s investors reportedly include Wellington, Fidelity, BlackRock (the New York investment manager that also owns shares in Exxon, Shell, McDonald’s and Nestle), and, best of all, Qatar’s sovereign wealth fund.
We are very far from the line of VC firms on Sand Hill Road. Andreessen's warning is self-serving. Local venture capital firms have got fat off easy money from institutional investors seeking growth. But the presence of interlopers means giant pools of money chasing too few good investments. Historically, this scenario has not ended well.
How will this play out?
If you know the answer, call me. Wld luv 2 talk. Watching startups like Uber, Airbnb, and Snapchat expand over the past few years has clamped down my knee-jerk notion that every bubble must burst. I think of it as a boom with bearable shockwaves that don't ripple out to the public markets. The dumb ones will disappear, margins will shrink, but the mega-valuations will stay in the billions.
But you should listen to professional investors like Gurley and Andreessen, who were pumping up valuations way before Qatar came calling. They have been sounding the alarm — loudly and across many, many tweets.
4/When the market turns, and it will turn, we will find out who has been swimming without trunks on: many high burn rate co's will VAPORIZE.— Marc Andreessen (@pmarca) September 25, 2014
In the same cover package where Fortune waxed poetic about unicorns and "decacorns" (don't ask), the magazine published Gurley's prediction that 2015 would be fail whale after fail whale. Given 80 minutes, you probably couldn't name half of those 80 startups worth $1 billion. Gurley said startups will collapse under the burden of heavy valuations and constricting liquidation preferences that say who gets paid first if and when there's an exit. But I get the sense he's opining on other people's companies. One source said Gurley — who, if you'll recall, was an Uber investor — had Lyft in mind when he started ringing the alarm.
Unrealistic expectations sunk former stars like Zynga, which was valued at $10 billion in June, 2011, which went public six months later at $7 billion and is currently trading at a market cap of $2 billion.
But cautionary tales like Zynga don't seem to be getting any play right now. Unicorn chasers still point to Facebook as proof that you can grow now, monetize later. The social network did not go public until it was valued at more than $100 billion and is currently trading at a market cap of $223 billion. The source who shared Pinterest's revenue told me that "eventually companies have to grow into their valuations, but not that soon. Someday the reality will set in," and then they'll be valued on revenue.
Someday is definitely not this week.