"When Cowboy Ventures founder Aileen Lee coined the term unicorn as a label for such corporate creatures in a November 2013 TechCrunch blog post, just 39 of the past decade’s VC-backed U.S. software startups had topped the $1 billion valuation mark. Now, casting a wider net, Fortune counts more than 80 startups that have been valued at $1 billion or more by venture capitalists."
Again, this is because interests rate, in general, are very low, much lower now than they were during the original Dot Com boom, which is why valuations are higher. The math on this is simple.
Suppose you have a company that makes $1 million in profits. The question then is, at what point does it make sense to invest in something else? When prevailing interest rates are 10%, then $1 million is 10% of $10,000,000, so the company is worth $10,000,000 (excluding a million other factors for the sake of a simple model). If the company demands more than $10,000,000 to buy it, then it makes sense to invest in something else instead. If a company wants less than $10,000,000 for ownership, then it is a hot deal.
But when prevailing interest rates drop to 1%, as now, and since $1 million is 1% of $100,000,000, then for same level of profit, the value of the company has gone from $10,000,000 to to $100,000,000.
Again, there are a million other factors you could consider (do you trust the management, can they scale, how fast are they growing) but I'm going with a simple model here to demonstrate the basic driving force of modern valuations: when interest rates go down, valuations go up.
Of course, that doesn't explain why a web startup with no profits would be valued more than, say, a mature company like GE, which has known profits. Some of the wilder valuations are obviously being driven by speculation about wild growth rates.
I completely agree that low interest rates are to blame for these high valuations, but your numbers example seems off. By that logic, shouldn't company valuations shoot to infinity if interest rates reach 0% (which they effectively have).
Those are just the very low interest rates the central bank sets. In practice there will always be higher rates for higher risk loans, especially corporate bonds. The point is valid to some extent but must take account of all investment alternatives and the risk.
That said, I can't help but intuit that these valuations are the result of too much cheap money. The closest phenomenon is probably rich people bidding up fine (and otherwise) art. Seriously, do economists study the difference between extra cash in the hands of very rich people vs everyone else?
Valuations would go to infinity if both the following were true: (1) Interest rates are zero; (2) investing in a company brings an expectation of nonzero returns. (More precisely: returns sufficient to outweigh the risk that the company fails.)
Unless everyone in the market is grossly irrational, 1 and 2 should not both remain true for long. If you can invest in FooCorp and make 1% per year (after adjusting for risk) then you will be happy to pay 0.5% per year to borrow money, and there will be people who will be happy to lend to you on those terms.
Yes, valuations would shoot to infinity if investors believed that interest rates would reach 0% and then stay there forever. Finite valuations are based on the idea that, at some point in the future, interest rates will be above 0%.
Also, although interest rates for the national governments of some countries have reached 0%, or even negative numbers, commercial interest rates are still slightly positive.
The interest rate in question here is probably the long-term rate, which is unlikely to go to 0. That would indicate a wide-spread belief that interest rates will remain at 0 for the foreseeable future, in addition to current interest rates being at 0. It's difficult to imagine a situation in which this would be true.
Taken by themselves, it is hard to say which one is overvalued. But looking at the entire class, I think they are definitely overvalued. The trick will be to figure out which one of these companies is the Amazon among the Webvans....
What I mean by 'class' is the slew of companies now valued at 1B+. Not sure what googles valuation was in 1999? I am guessing it was still well below 1B.
I feel a terrible unease about these companies. It's not the bloated valuations, but rather the motivation for running companies in this way. The plc has many critics, as a model of risk sharing and financial transparency it's got huge holes right through it as Enron (and other car crashes) showed. But who has a clue about what's happening in these companies, and who, and what (banks, pension companies, taxpayers, plc's) are being taken for a ride?
I get you. Just yesterday I was thinking about how valuable everything these companies give us for free is, and how Google specifically has completely distorted what people's perceptions are on the value of software, especially email. Google can have 50 loss leaders that completely obliterate the ability to profit in certain segments for other companies, and they're so massive they don't even feel it.
This is actually a very common problem we see with our service. Tons of 1 star reviews in Play/iTunes because we dare to withhold (valuable) features in order to make enough profit to run the business. Once a week we get very very negative (read: swearing) emails to customer support about needing a paid account to do certain things. Kinda a shame, considering the sheer value we offer 98% of our free users because 2% actually pay.
Actually right now I'm geocoding about 100k addresses for completely free via Google's APIs. Something that would have cost a few hundred dollars a few years back, at the very least.
Consider Facebook's valuation and then consider how they actually make money. Do they even make money outside of advertising, and is that advertising over valued? How many advertisers have already pulled out of Facebook ads due to ineffectiveness?
A lot of these companies are valued solely on the number of users, and little to due with anything else. Maybe someday they will spin it and turn all those users into profit, that seems to be the dream. It's not always a viable reality.
The amount of data Facebook is able to collect on their users is the difference for them, and the value of data for hundreds of millions of users is hard to quantify.
That seemed pretty convincing, but then I added some comparison terms like "instagram" and "snapchat"... they are hardly a blip. I think that argues that the world is going mobile, but then maybe google trends isn't a fair way to measure who is walking where.
"When Cowboy Ventures founder Aileen Lee coined the term unicorn as a label for such corporate creatures in a November 2013 TechCrunch blog post, just 39 of the past decade’s VC-backed U.S. software startups had topped the $1 billion valuation mark. Now, casting a wider net, Fortune counts more than 80 startups that have been valued at $1 billion or more by venture capitalists."
Again, this is because interests rate, in general, are very low, much lower now than they were during the original Dot Com boom, which is why valuations are higher. The math on this is simple.
Suppose you have a company that makes $1 million in profits. The question then is, at what point does it make sense to invest in something else? When prevailing interest rates are 10%, then $1 million is 10% of $10,000,000, so the company is worth $10,000,000 (excluding a million other factors for the sake of a simple model). If the company demands more than $10,000,000 to buy it, then it makes sense to invest in something else instead. If a company wants less than $10,000,000 for ownership, then it is a hot deal.
But when prevailing interest rates drop to 1%, as now, and since $1 million is 1% of $100,000,000, then for same level of profit, the value of the company has gone from $10,000,000 to to $100,000,000.
Again, there are a million other factors you could consider (do you trust the management, can they scale, how fast are they growing) but I'm going with a simple model here to demonstrate the basic driving force of modern valuations: when interest rates go down, valuations go up.
Of course, that doesn't explain why a web startup with no profits would be valued more than, say, a mature company like GE, which has known profits. Some of the wilder valuations are obviously being driven by speculation about wild growth rates.