TweetStorm: Start Up Valuations

Posted March 5, 2016

An excellent Twitter thread posted by Marc Andreesen (@pmarca) on start up valuations. For the original thread with comments and such, go here.

1/  A few common fallacies about valuation of public and private technology companies:

2/  First, ask any MBA how to value tech companies, she’ll say “ discounted cash flow, just like any other company.”

3/  Problem: For new [and] rapidly growing tech [company’s], up to 100% of value is in terminal value 10+ years out, so DCF framework collapses.

4/  You can run as many DCF spreadsheets as you want and may get nothing that will help you make good tech investment decisions.

5/  Related to fact that tech [companies] don’t have stable products like soup or brick companies; future cash flows will come from future products.

6/  Instead, [a] smart tech investor thinks about: [1] future product roadmap [and opportunity], [2] bottoms-up market size [and] growth, [3] talent and skill of team.

7/  Essentially you are valuing things that have not yet happened, and the likelihood of the CEO and team being able to make them happen.

8/  Finance people find this appalling, but investors who do this well can make a lot of money, but spreadsheet investing is often disastrous.

9/  Doesn’t mean cash flow doesn’t matter, in fact opposite: this is the path to find tech companies that will generate tons of future cash.

10/  Corollary: For tech companies, current cash flow is usually useless for forecasting future cash flow [because current cash flow is a] lagging not leading indicator.

11/  This trips up value investors … all the time; tech companies with high cash flows [are] often about to fall off a cliff.

12/  Because current cash flows are based on past products not future products. And [in a startup] profitability often breeds complacence and bureaucracy.

13/  Always, always, always, the substance is what matters: WHO and WHAT. WHO [is] building the products, and WHAT products are they building.

14/  Brand will not save you, marketing will not save you, channels will not save you, account control will not save you. It’s the products.

15/  Which goes right back to the start: Who are the people, what are the products, and how big is the market. That’s the formula.

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