2025, you’re lining up for the long expected docufiction about the 2016 startup scene

There has been, what sounds to me, crazy discussions recently on the profitability of Silicon Valley startups and the related cautiousness of investors.

Recognized investors such as Chamath Palihapitiya (Social Capital) have made pretty clear that the market has turned crazy in some areas such as the delivery and food businesses, where most of the companies are not even making profits at the gross margin level. A similarly interesting analysis came from Alex Chuang describing the “water bears” now replacing unicorns, thanks to a consistent focus on the three growth levers of acquisition, retention and monetization. And lastly, one of the best might be Bill Gurley’s post looking at the emotional biases of market participants from CEOs to investors.

Abovethecrowd.com on April 21st 2016: Many have noted that the aggregate shareholder value created by all of the Unicorns will vastly overshadow the losses from the inevitable failed unicorns. This likely truism is driven by the clear success of this generation’s transformational companies (AirBNB, Slack, Snapchat, Uber, etc). While this could provide some sense of comfort, most are not exposed to a Unicorn basket, and there is no index you can buy. Rather, most participants in the ecosystem have exposure to and responsibility for specific company performance, which is exactly why the changing landscape is important to understand.

And then I was the amused spectator of a discussion on Linkedin, with people discussing the rationality of focusing on profits. Having studied finance and worked in investment banking it was quite surprising even though I’m far from being an expert on startups valuation and funding. Please find below a few quotes from this same discussion:

As the new CEO observed on Silicon Valley a couple of weeks back, their product is the stock (and, of course, everything is perfectly accurate on SV). So Uber losing money doesn’t matter when stock prices/valuations are supported by 20 years of tech telling us the profit and loss is an outdated concept (which is apparently true when your product is the stock).

If their business model was created to be profitable, then they would be failing. However, profitability is not the goal, growth is.

IMHO, you’re asking the wrong question. There’s no need to be profitable while access to capital is so cheap and capital is desperately searching for decent return (real or otherwise). Slack for example has publicly said they don’t have any real need for the $$ the last few rounds have funding have brought in. The bigger question IMHO is which of those companies can ride out a drying up of access to cheap capital. It potentially becomes a self fulfilling prophecy (eg. My business model looks pretty damn good if my competition goes out of business).

Let’s analyze these comments.

What if profits aren’t a good metric? Yes this statement can be relevant, as in some industries the focus is more on the cash flow generation and the balance sheet net asset value than the bottom line of the P&L. This different focus can be justified by the dividend policy (cash flow generation related) and the asset turnover (disposals). Listed commercial real estate companies fit this description. But, to be noted, they still generate profits in order to reinvest in their assets, which are depreciating over time.

What if stock was a more relevant metric for valuation? Once again, similar to real estate there are few industries where the balance sheet tends to be a more relevant focus than the P&L, such as the Hollywood studio industry where the box office tends to be (more and more likely) a minor part of the film equation and the revenues are spread over a few years based on windowing local regulations/practices. One of the main challenges here, is the growing risk (beta) associated with these strategies as delayed revenues tend to be synonym to higher uncertainty especially in fast moving industries where scarcity still has to be discussed. Basically until now the market has postively apprehended this uncertainty which was synonym of future favorable (inflated) monetization justifying the discounted current valuation. You basically expect to sell more tomorrow to the audience you’re building today. Or not…

What if you just care about the exit valuation? Another way to gauge the value of this stock would be through the exit option, selling your business to a larger entity making profits out of your audience thanks to a synergistic multi-platform ecosystem. Then come the greedy Amazon and Facebook of this world. How many of these new digital platforms have created such a strong brand that they can justify this behavior? In light of GAFA’s current aggressive (organic) development accross platforms and services, I personally would not bet too much on this option.

Overall it seems to me it’s just irrational behaviors, likely just part of the ups and downs of the market. At some point you can also compare that to any large market bubble. Just made me think about the movie The Big Short and some crazy characters described in it…