People are empowered by their lack of power. Malcolm Gladwell

The Arcane Art of Private Market Valuation

The logic of the social media market: Have an idea, expand quickly, and monetarize it before imitators arrive. Investments and values reach unprecedented heights. All ingredients for an unwanted bubble are there.

10 years ago was the beginning of the end of the boom. Trends in the internet develop fast positions on the leading edge don’t have much runtime before imitators or new ideas arrive. Get attention, get investment, get monetized, do it fast and hope you hit it bigtime with a new Facebook or Groupon.

The health of an entrepreneurial economy is represented by the number of IPO’s it generates. The current regulatory environment has put many relationships and behaviors under scrutiny making IPO’s vastly more complicated and legally expensive. Good ideas and companies no longer get financed easily. IPO’s that used to take 5 years now take 10 years. It is harder for founders, first movers and employees to cash out.

New market mechanisms evolve to meet needs in the current universe of buyers and sellers that fulfill the two very necessary functions of allowing investors to cash in and founders to cash out.
We are on the cusp of the next boom in digital media investment, what could be the 21st Century NASDAQ. Heavily fueled by Social Media startups and firms looking to invest in the next big thing. 12,000 new companies, mostly technology will be added to the Second Market exchange this week, 20x the current pool. Significant, highly siloed social networking components will also be included. Wall Street is creating private investment vehicles focused on startups you have heard of like Zynga, Groupon and Linkedin which have revenue streams and many others that don’t.

Social Media is already frothy with investors whose appetites have been whetted by publicity. This world is ripe with new companies looking for investment. FB, LinkedIn, Twitter, Foursquare, a lot of other pre-ipo VC backed companies. All have been ‘media driven’ to become the next wave of hot companies in which it was very hard to participate. Inavailability drives desire, Goldman Sach’s affair with Facebook has stimulated the appetite of investors and funds while making future investment opportunities available for a select few foreign investors. Allowing investors to buy into pre-IPO companies that previously were not easily accessible except to VC’s is the key.

“In an already frothy market this is coldly calculated to whet their appetites.”

Groupon with 3000 employees can translate into a lot of action. $200M in FB was a major prize but this translates into perhaps 1% of stock, maybe from just one employee. People will jump on the next available thing for fear of being left behind. The innovation cycle in this industry is based on short term trends.

Last week Angry Birds a popular mobile game from Rovio raised $42MM in a round led by FB, GO and Skype. This company with 50 employees has stimulated a lot of attention and questions. Does a global brand translate into a business model? If you can grab enough eyes you can get a deal, buyers will figure out how to make money later. Buy while its hot. Great precursor publicity, these deals may be the cure to an illiquid and broken market but most new companies may not have revenue streams or sufficient extant information to make a realistic price evaluation in the private market.

Exchanges open for trading private company shares suit the needs of the sellers, the buyers and the regulators who are happy to see some transparency, contract standardization, price history and accounting trails in a previously dark market. Exchange like environments cure a lot of headaches for start-ups, they keep track of shareholders to make sure the total count does not exceed 500, meaning filing financial results or go public and help value private stock the pricing of which in early stage tech companies is a black art.

Adding new asset classes to drive the off exchange market will increase velocity and flow in the venture world because every investor wants to be in the next $200M company. This market is huge with pooled investment vehicles rapidly appearing looking for deals. Every VC wants to make a $200M company Into a $6B one. If you have a portfolio of 50 companies your concern is spotting the one that’s going to make you 10x on your money so shoot for the moon. This is where Wall Street hopes to find that next $200M company which will turn into a $6B one. No one wants to be left behind and while they may not be intending to make a bubble but all the elements are there.

Read more in this debate: Timo Leimbach, Carlota Perez.


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