Simon’s Blog

There continues to be lots of talk about the valuation of Facebook. One of Facebook’s founders has apparently suggested that they wouldn’t sell the company for less than $10B; and, as I wrote recently, people have been advising the owners of Facebook that it would be a big mistake to sell for $6B. Instead, the view seems to be that an IPO is the right way forward for the company. I guess it might be. Equally, however, it might not. I wonder if people have really thought this through. Why? Because as far as getting a valuable exit goes, there’s a big difference between being privately held and being a public company. I think that difference could be a problem for Facebook. Here’s why…

If you’re a super-hot company, as Facebook is, there’s always a chance that a single buyer could come along that feels they really need to acquire you. For whatever reason, the buyers might well feel that they simply cannot do without your company. It’s what’s called a “strategic” purchase; and a key characteristic of strategic purchases is this - rational thoughts on valuation often fly out of the window.

But here’s the thing… the scenario above works only if you’re a privately held company. Why? Because, with a privately held company, there is no ceiling to the valuation that can be achieved (there’s no floor either, but that’s a different discussion). If you can find the right buyer, the sky really is the limit. That’s because there are no solid guides to the company’s valuation - pretty much all that’s available are: the price paid at the last investment; (sometimes vague) comparator valuations; and maybe some term sheets from previous deals that fell through. In that kind of situation, people can persuade themselves of anything.

However, if you’re a public company, there is a solid guide to valuation - the company’s market cap. The market cap represents something close to the ceiling of the company’s sale price. So, if the public market values your company at $1B, there is zero chance of an acquirer needing to pay $10B to get their hands on the company.

The big questions, then, are… What value would the public markets put on Facebook? And, even assuming that they achieved a big valuation at IPO, what could the company do to sustain its valuation over the medium term? If the rumours about Facebook’s revenues, and where they come from, are true, I think there’s a risk that the share price of a public Facebook could be pretty fragile.

It will be pretty interesting to see how this one plays out…