Menus Subscribe Search

The Future of Money

whatsapp

(Photo: 360b/Shutterstock)

Why Are So Many Silicon Valley Companies Valued in the Billions?

• April 23, 2014 • 4:00 AM

(Photo: 360b/Shutterstock)

WhatsApp, Oculus, Instagram, Tumblr: These are just some of the technology companies recently valued at $1 billion or more. Whether we’re in a start-up bubble or not nobody can agree on, but one thing is certain: We have no idea what the future looks like, and an investment today could result in huge profits tomorrow.

In HBO’s new technology-business satire Silicon Valley, the bumbling protagonist Richard Hendricks stumbles upon an algorithm that compresses large digital files into smaller ones without sacrificing their quality. Hendricks is promptly offered $10 million for his tiny start-up by the founder of his employer, a Google-like entity called Hooli. Another investor jumps up to buy five percent of the company for $200,000. Those are both cheap price tags for what almost every character in the show refers to as a “billion-dollar” idea.

But what is the idea, precisely? As the investor Hendricks eventually chooses points out, the young entrepreneur doesn’t have any actual customers or a strategy to make money; he doesn’t have a business plan, let alone know what one looks like. When the first investment check comes, the founder doesn’t have a company bank account to deposit it in. Yet “this could be a billion-dollar company” becomes a refrain for the show’s characters, who jostle for equity and cling to the hope that all this could someday lead to the show’s other catchphrase: “making the world a better place.” Oh yeah, and bags of money.

Silicon Valley is spot-on: Start-ups being valued at billions of dollars seems to be the new normal. In fact, $1 billion isn’t even the highest a company might aim. In 2012, Facebook bought Instagram for $1 billion (just slightly less than what Yahoo paid for Tumblr last year), but more recently it was rumored to have offered the ephemeral messaging service Snapchat in excess of $3 billion. In February, Facebook dropped $19 billion on the international messaging platform WhatsApp.

Facebook is starting to look more like a digital holding company—a business that controls stock majorities or owns outright other, smaller companies and profits from them.

It’s hard to judge just what a start-up valuation means right now. The high prices and hype suggest that a bubble is building, and some are already suggesting that it’s on its way to popping (or at least losing air). High valuations are a self-reinforcing loop: Lots of venture capital flowing around the technology sector means more companies achieving high sale prices and positive results for their investors, which encourages even more investors to jump in and gamble small amounts of angel investment (often the first amounts of money a company receives in exchange for a small percentage of equity, as in Hendricks’ case) for big pay-outs later.

Examples abound. The DIY-hotel platform AirBnB just raised another $500 million, valuing the company as a whole at $10 billion (it reported revenue of $250 million in 2013). Yet the company faces legal pressure from state governments to regulate its users; unfavorable legislation could shut down its core business entirely.

Quora, a question-and-answer website with no source of revenue, recently netted $80 million in investment on a valuation said to be around $400 million. The $80 million would go not toward developing new products, the company’s founders said, but to the bank as an insurance policy to keep the company afloat long-term. “We raised money because we think it helps us ensure our independence and permanence,” Quora’s business and community leader Marc Bodnick told the New York Times. In other words, to ensure that they’ll still be around when the venture-capital flood dries up.

So if it’s not direct revenue and it’s not sustainability (as many as three out of every four start-ups fail, losing money for investors), what is it exactly that’s driving sky-high prices for start-ups?

The most basic answer is the companies’ expansion possibilities. AirBnB focuses on turning apartments into rentable hotels for now, but it plans to move into other areas of the hospitality industry, integrating an entire travel experience into one service. Uber, a company that runs a digital network of taxicabs and amateur drivers ready to pick up any fare, is valued at around $3.5 billion and faces regulatory measures similar to AirBnB. What opens investors’ wallets is Uber’s push into delivering not just people but transporting anything and everything and tracking it in real time—the company recently launched a courier service in New York.

These companies’ valuations are also about competition. As one-time start-ups like Facebook and Twitter continue to grow following their IPOs, they are morphing into large corporations, competing with places like Google over who is going to control the next generation of successful tech companies. Indeed, Facebook is starting to look more like a digital holding company—a business that controls stock majorities or owns outright other, smaller companies and profits from them—than a social network. In a bid to hit the jackpot on the next big thing, it recently bought Kickarter-funded Oculus—for $2 billion—which makes virtual reality devices, and had expressed interest in Titan Aerospace, a drone manufacturer, before Google (Facebook’s chief competitor in the escalating acquisition wars) snapped it up.

Tech companies are also invested in sustaining the hype surrounding their own industry. News of high-profile acquisitions, leaked to the biggest publications, build buzz for even more high-profile acquisitions, and in the industry’s ongoing consolidation, the next big buy might just be that of your own company. As the Titan Aerospace news shows, Facebook may even encourage rumors of its negotiations, whether they’re successful or not.

Yet the biggest reason for billion-dollar valuations, bubble or not, is the optimistic futurism of technology entrepreneurs. Value has become an abstraction because we don’t really know what kind of product is going to make the most money. We have no idea what kind of technology will dominate the commercial landscape over the next decade, let alone century, but making the right bet and getting in on the bottom floor could mean massive profits. Rather than building a better mouse trap, tech companies are chasing immaterial products with implications and business plans they won’t fully understand until the future.

That separation between old-school entrepreneurship and valley-style abstraction is illustrated in Silicon Valley when Hendricks’ compression company runs into a copyright problem. They want to call the company Pied Piper, but an irrigation-system business already exists under that name. Hendricks goes to bargain with the folksy farmer-type who owns it, looking out over a field of spraying sprinklers. “What does your business do, again?” the older man asks. “Something to do with algebra?”

Kyle Chayka
Kyle Chayka is a freelance technology and culture writer living in Brooklyn. Follow him on Twitter @chaykak.

More From Kyle Chayka

A weekly roundup of the best of Pacific Standard and PSmag.com, delivered straight to your inbox.

Recent Posts


August 29 • 4:00 PM

The Hidden Costs of Tobacco Debt

Even when taxpayers aren’t explicitly on the hook, tobacco bonds can cost states and local governments money. Here’s how.


August 29 • 2:00 PM

Why Don’t Men and Women Wear the Same Gender-Neutral Bathing Suits?

They used to in the 1920s.


August 29 • 11:48 AM

Your Brain Decides Whether to Trust Someone in Milliseconds

We can determine trustworthiness even when we’re only subliminally aware of the other person.


August 29 • 10:00 AM

True Darwinism Is All About Chance

Though the rich sometimes forget, Darwin knew that nature frequently rolls the dice.


August 29 • 8:00 AM

Why Our Molecular Make-Up Can’t Explain Who We Are

Our genes only tell a portion of the story.


August 29 • 6:00 AM

Strange Situations: Attachment Theory and Sexual Assault on College Campuses

When college women leave home, does attachment behavior make them more vulnerable to campus rape?


August 29 • 4:00 AM

Forgive Your Philandering Partner—and Pay the Price

New research finds people who forgive an unfaithful romantic partner are considered weaker and less competent than those who ended the relationship.


August 28 • 4:00 PM

Some Natural-Looking Zoo Exhibits May Be Even Worse Than the Old Concrete Ones

They’re often designed for you, the paying visitor, and not the animals who have to inhabit them.


August 28 • 2:00 PM

What I Learned From Debating Science With Trolls

“Don’t feed the trolls” is sound advice, but occasionally ignoring it can lead to rewards.


August 28 • 12:00 PM

The Ice Bucket Challenge’s Meme Money

The ALS Association has raised nearly $100 million over the past month, 50 times what it raised in the same period last year. How will that money be spent, and how can non-profit executives make a windfall last?


August 28 • 11:56 AM

Outlawing Water Conflict: California Legislators Confront Risky Groundwater Loophole

California, where ambitious agriculture sucks up 80 percent of the state’s developed water, is no stranger to water wrangles. Now one of the worst droughts in state history is pushing legislators to reckon with its unwieldy water laws, especially one major oversight: California has been the only Western state without groundwater regulation—but now that looks set to change.


August 28 • 11:38 AM

Young, Undocumented, and Invisible

While young migrant workers struggle under poor working conditions, U.S. policy has done little to help.


August 28 • 10:00 AM

The Five Words You Never Want to Hear From Your Doctor

“Sometimes people just get pains.”


August 28 • 8:00 AM

Why I’m Not Sharing My Coke

Andy Warhol, algorithms, and a bunch of popular names printed on soda cans.


August 28 • 6:00 AM

Can Outdoor Art Revitalize Outdoor Advertising?

That art you’ve been seeing at bus stations and billboards—it’s serving a purpose beyond just promoting local museums.


August 28 • 4:00 AM

Linguistic Analysis Reveals Research Fraud

An examination of papers by the discredited Diederik Stapel finds linguistic differences between his legitimate and fraudulent studies.


August 28 • 2:00 AM

Poverty and Geography: The Myth of Racial Segregation

Migration, regardless of race, ethnicity, gender, or sexuality (not to mention class), can be a poverty-buster.


August 27 • 4:00 PM

The ‘Non-Lethal’ Flash-Bang Grenades Used in Ferguson Can Actually Be Quite Lethal

A journalist says he was singed by a flash-bang fired by St. Louis County police trying to disperse a crowd, raising questions about how to use these military-style devices safely and appropriately.


August 27 • 2:00 PM

Do Better Looking People Have Better Personalities Too?

An experiment on users of the dating site OKCupid found that members judge both looks and personality by looks alone.


August 27 • 12:00 PM

Love Can Make You Stronger

A new study links oxytocin, the hormone most commonly associated with social bonding, and the one that your body produces during an orgasm, with muscle regeneration.


August 27 • 11:05 AM

Education, Interrupted

When it comes to educational access, young Syrian refugees are becoming a “lost generation.”


August 27 • 9:47 AM

No, Smartphone-Loss Anxiety Disorder Isn’t Real

But people are anxious about losing their phones, even if they don’t do much to protect them.


August 27 • 8:00 AM

A Skeptic Meets a Psychic: When You Can See Into the Future, How Do You Handle Uncertainty?

For all the crystal balls and beaded doorways, some psychics provide a useful, non-paranormal service. The best ones—they give good advice.


August 27 • 6:00 AM

Speaking Eyebrow: Your Face Is Saying More Than You Think

Our involuntary gestures take on different “accents” depending on our cultural background.


Follow us


Subscribe Now

Your Brain Decides Whether to Trust Someone in Milliseconds

We can determine trustworthiness even when we’re only subliminally aware of the other person.

Young, Undocumented, and Invisible

While young migrant workers struggle under poor working conditions, U.S. policy has done little to help.

Education, Interrupted

When it comes to educational access, young Syrian refugees are becoming a “lost generation.”

No, Smartphone-Loss Anxiety Disorder Isn’t Real

But people are anxious about losing their phones, even if they don’t do much to protect them.

Being a Couch Potato: Not So Bad After All?

For those who feel guilty about watching TV, a new study provides redemption.

The Big One

One in two full-time American fast-food workers' families are enrolled in public assistance programs, at a cost of $7 billion per year. July/August 2014 fast-food-big-one

Copyright © 2014 by Pacific Standard and The Miller-McCune Center for Research, Media, and Public Policy. All Rights Reserved.