By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street.
How much does it cost to manipulate an entire market? Not much. And it’s getting cheaper!
It was leaked on Tuesday by “people with knowledge of that matter,” according to the Wall Street Journal, that VC firm Kleiner Perkins Caufield & Byers had decided in May to plow up to $20 million into message-app maker Snapchat, for a tiny portion of ownership. An undisclosed investor also committed some funds. The deal, which apparently hasn’t closed yet, would give Snapchat a valuation of $10 billion.
That’s a big step up from November last year, when the valuation was $2 billion. At the time, the company had raised $130 million in three rounds of funding. By now that would be closer to $160 million, after it was also leaked that Russian investment firm DST Global had put some money into it earlier this year, boosting its valuation to $7 billion at the time, once again, “according to two people familiar with the matter.”
At a valuation of $10 billion, it joins the top of the heap: app makers Uber ($18.2 billion) and Airbnb ($10 billion), cloud storage outfit Dropbox ($10 billion), and Palantir, the Intelligence Community’s darling ($9.3 billion).
Unlike the others in that group, Snapchat is marked by the absence of a business model and no discernable revenues. But there is hope that it could eventually pick up some revenues by advertising to its 100 million or so users, mostly teenagers and college students, without turning them off.
But in this climate, no revenues, no problem. Into the foreseeable future, the company will produce a thick stream of undisclosed red ink.
But the investment was an ingenious move.
For KPCB, a huge VC firm, the investment would amount to petty cash. Why did it do this deal? If it could exit at an enormous valuation of $20 billion, it would only double its money – a paltry multiple, given the risks. It would only make $20 million, still petty cash. But there was a reason….
By strategically deploying less than $30 million, KPCB, and DST Global before it, have ratcheted up Snapchat’s valuation from $2 billion to $10 billion. With the stroke of a pen, in a deal negotiated behind closed doors, they have created an additional $8 billion in “wealth” that is now percolating through the minds of employees with stock options and through the books of the early investment funds.
Snapchat’s new valuation isn’t an isolated event. It’s a product of all recent valuations, and it is itself now ricocheting around and is used to set the valuations at other startups. That’s the multiplier effect. What seemed like an absurd valuation yesterday becomes the norm tomorrow, on the time-honored principle that once a valuation is already absurd, it no longer faces resistance from any rational limit. And nothing stands in the way for the multiplier effect to ratchet valuations ever higher.
Nothing, except the potentially troublesome exit for these investors. Because, without exit, these paper gains will remain paper gains, and eventually will disintegrate into dust.
To exit gracefully, investors can sell the company via an IPO mostly to mutual funds and ETFs that are stashed in retirement funds and investment portfolios. Or they can sell it to giants like Facebook or Google that can pay cash (borrowed or not) or print their own currency by issuing shares, both of which come out of the pocket of current stockholders. At the far end of both transactions are mostly unwitting retail investors.
Inflating Snapchat’s valuation by $8 billion with a few million dollars rigs the entire IPO market that depends on buzz and hype and folly to rationalize these blue-sky valuations. Unnamed people “knowledgeable in the matter” who leak these valuations to the Wall Street Journal are an integral part of the hype machine: It balloons the valuations of other startups. And it creates that “healthy” IPO market where money doesn’t matter, where revenues and profits are replaced by custom-fabricated metrics.
The hope is that the IPO market remains “healthy” long enough for investors to be able to unload hundreds of these companies at crazy valuations. The hype surrounding these valuations is creating more enthusiasm about IPOs in a self-reinforcing loop. The hope is also that the broader stock market continues to soar so that potential acquirers can print more overvalued shares to acquire more overvalued startups so that the exists can come about. Under the motto: after us the deluge.
The deluge will wash over retail investors.
While it’s possible that one or the other startup might become the next Facebook or Google, there are only a few Facebooks and Googles, but there are many startups whose business model and permanent lack of profits will eventually bring them down to reality, either in the portfolios of retail investors, or as a write-off by the acquirers, whose shares are also stuffed into the nest eggs of retail investors. Along the way, Wall Street extracts fees from all directions. That’s the Wall Street money transfer machine. It smells like a rose when all stocks go up, but when the tide turns…. OK, that won’t ever happen.
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There is another side to this however, one which I’m sure is used as a rationalisation by the pump-and-dump-ers. The only thing that will discipline retail investors is the loss of their money. In one sense it is better for retail investors — and pension funds — to get burned early and often, so that they become more prudent and demand more prudence from their brokers. The problem is that with our current herd-mentality market, retail investors sometimes don’t get burnt for years, and spend these getting more and more caught up in bubbles, at the end of which it becomes more and more difficult to bin the blame on them alone.
Boiler Room!
Everyone wants employment growth. More projects and more risk taking… of course many companies will fail for each surviving one. Someone needs to finance these start-ups… so which one is it… government or the private side?
If government finances these failures, then the public complains and refuses to pay anymore taxes. Since the USA abhors the word socialism, it pushed market making onto pension plans… so we have huge amounts of money sloshing around looking for LARGE & GUARANTEED returns…. hmmm, aren’t these 2 contradictory? Nobody wants to pay taxes and many are quite happy when government just prints the difference… history has shown time and time again that the p9pulatin does not realize that over printing always leads to malinvestment which is a hidden tax on everyone’s $. For some reason people think printing without proper checks and balances will lead to prosperity. Anyhow, we’ve gone down the rabbit hole of cutting taxes and printing the budget difference and we have proof that things are already out of control but most refuse t see it.: corrupting M&A based on financial engineering, etc.
Because of a rigid ideology and delusions, we are now stuck with huge malinvestment. Even profitable companies should not be the size they are for the sake of a thriving and harmonious society. Frankly, whether it gets financed from private money or government money, I don’t know how we will manage to determine where money should be invested to 1. Preserve the environment, 2. benefit the MST people as possible.
We are so far down the path of decadence that for me there is NO quick fix and pain for many is a certainty. Hug those around you, you will need each other.
‘The hope of private equity investors is that the IPO market remains “healthy” long enough for investors to be able to unload hundreds of these companies at crazy valuations.’
Fixed it for ya!
Exactly. The game is functioning exactly as intended.
Nobody bothers to trace the return-on-innovation of the original team that took the intellectual and sweat-equity plunge. There are a few, like Zuckerberg of Facebook (though there’s plenty of controversy there, too) but many of the folks that do the actual innovating fall out of the bottom of this sieve while the VCs (Vulture Capitalists) always make out like bandits.
Most of those who take the kudos and money are rarely the ones who really created or invented stuff… it’s usually the riders on the coattails.
It takes a village to raise a child but Americans really LOVE the concept of a self-made man. As if…
What method is used to determine “valuations” of these private companies? Percent of ownership received (which we don’t know)? Revenue projection? Discounted cash flow forecast from currently non-existent revenue stream? Unicorns and ponies for Sand Hill Road?
We have little visibility to what the deal looks like, preferential positions, options, exits, etc. Much less how the prior equity injections were structured.
BTW, the total cash investment in Snapchat is about $175MM, nothing like $9.8 billion in goodwill.
Gotta love leverage
The root cause of this. Is the Fed stupid and evil?
Money is being corralled and funneled into the only game left, the stock market yard. Pension funds are the judas steer, leading the parade to the slaughterhouse. What else can wee dooooo?
Evil, as are all debt based money system from the private sector.
This article is complete nonsense. The author has not proven how KPCB intends to get its money out other than by the company being bought or selling stock at a higher valuation. They are not going public unless they can make significant revenue btw, including earnings. KPCB must feel that they will double their investment in a short period so the risk of a relatively small amount of capital is worth it. Venture funding is fairly competitive and funds do their best to get returns and represent the interests of their LPs (investors). I am no apologist for venture having been at their mercy before but they will do what is in the best interest of their LPs and that is not inflating the valuation and investing too high to recoup their money. They are always trying to push valuation down when they invest unless they are early investors and are trying to push it up later with smaller amounts so their original investment is worth more.
They are not going public unless they can make significant revenue btw, including earnings. KPCB must feel that they will double their investment in a short period so the risk of a relatively small amount of capital is worth it
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Not necessarily, maybe the venture capitalists at this point in the game don’t care about the end result of IPOing… if they:
1. Can get other people’s money
2. Leverage that amount
3. Pay themselves outrageous fees and bonuses
4. Structure the VC firm/fund in such a way someone else take the loss in due time.
Then what do they care if they can IPO or not.. I think a lot of people are oblivious to how malinvested our money is after bailouts, QE and zirp. Anyone expecting economic improvements for the masses is deluded.
Your error is in not looking at the big picture. Kleiner Perkins doesn’t care about snapchat. They weren’t one of the early investors so they’re not going to get much money even with a successful IPO.
But Kleiner Perkins has a hundred *other* internet companies with dubious profit models in which they have substantial shares. If by buying $20mil of snapchat, they can cause snapchat’s valuation to increase 5x from last year, and now everyone starts using that valuation as the “new normal” for all internet companies, then with a piddly $20mil, Kleiner Perkins has raised the valuations of all of their other, actual investments by 5x. As they IPO and exit these other investments, that $20mil will be paid over numerous times in inflated valuations of all their other companies. Snapchat doesn’t even have to IPO. All that Kleiner Perkins needs is for everyone to believe the new valuation is the “industry normal”. That’s how the pump-n-dump game works on Sand Hill Road…