Simon’s Blog

Until you’ve been round the block a few times, if you own (or work at) a hot company, you believe that there’s only one direction for the valuation to go; and that’s up. People have been saying that Facebook shouldn’t sell out for $6B, because it’s soon going to be worth much more. Now, those people might well be right. However, let’s say, just for sake of argument, that we’re in a bubble right now. What could Facebook be worth if we’re in a bubble, and the bubble bursts before they sell? In other words, how low do valuations go when a bubble bursts?

The first thing to recognise is that valuations don’t go from “too high” to “about right”; they go from “too high” to “too low”. So, let’s use some hard data to make a concrete estimate. I was talking with some VC friends today, and we were discussing valuations of companies. They told me a story about one of their old portfolio companies (which shall remain nameless). The story was thus - during the last bubble, the CEO received an offer for the company - the price was $400M. The CEO thought it was such an insultingly low offer that he didn’t even bother to inform the board of the approach. He believed there would be no appetite for this deal. Fine (well it’s not, but let’s ignore the lack of communication). So, on they went, building out the company… and then… the bubble burst. Two years later, they sold the company for less than $20M.

These are interesting data points because they provide: a true market valuation near the height of a bubble i.e. a price someone would have really paid; and a true market valuation in the aftermath of the bubble bursting i.e. the price the company was really sold for. This data tell us that valuations can sometimes fall around 20X between the peak of a bubble and when the bubble has burst.

Now, as an example, let’s apply that to Facebook. It seems that Facebook management would reject an offer of $4B for the company. What if we’re in a bubble now? What if it burst? If you apply the numbers from the real-world scenario above, you end up with trade-sale price of $200M. Quite sobering, I think…