On Web Growth & Web $Growth$

Much has been made of Internet company valuation, and with the order of magnitude money has been flying at startups in the Valley, much demands investigation. Valuation is an inherently subjective process that can be made to conclude anything depending on methodology and assumptions. Value investors who prospered in the crash of 2000-1 were vindicated that company value is derived from a string of revenues, and the stock value is a claim on that string. The followers of Benjamin Graham's approach will only invest in stocks of companies with strings of positive Free Cash Flow that have a Net Present Value to the stock-holder.

Venture Capital Investing a Different Animal

Now, Venture Capital investing is far different from buying stocks listed on the NYSE, NASDAQ and S&P 500. Venture Capital investors have the flexibility to demand very sharp hook-clauses into the Term Sheets they give out. I just finished my MBA at the University of Chicago where we studied how to structure a Term Sheet to limit downside risk, and ensure a positive return with near certainty, while still having significant exposure to the upside should a startup venture succeed.

It's a powerful piece of knowledge to have as an asset manager who is renting money from wealthy individuals and institutions. In order to raise future funds, an asset manager must show returns greater than the stock market and other asset classes. The first Case Study in Professor Steven Kaplan's Entrepreneurial Finance & Private Equity class is a study of David Swenson, Chief Investment Officer of Yale's Endowment.

The Boston Globe wrote a story about a study by Josh Lerner of Harvard with colleagues:

It shows that $1 billion invested at the end of 1991 by the average US college or university endowment grew to $3.68 billion at the end of 2005, a gain of 268 percent over the 14-year period. That was slightly less than the 278 percent compounded growth of the benchmark Standard & Poor 500 stock index in the same period.

By contrast, a $1 billion investment by "Ivy Plus" school endowments turned into $5.88 billion, a gain of 488 percent. The Ivy Plus group was defined as Ivy League schools - Harvard, Yale, Brown, Columbia, Cornell, Dartmouth, Princeton, and Pennsylvania - plus the Massachusetts Institute of Technology, Duke University, Stanford University, and the California Institute of Technology.

Those very large endowments had access to the best VC funds and startup deals, with terms that would most benefit investments by Endowment managers in the role of Limited Partner. The investments grew the endowments of the Ivies so significantly that the schools are substantially liberalizing their tuition assistance. Here is Harvard's 3-Point Initiative to lower Expected Family Contributions.

To an entrepreneur, the experience can look more like this anonymous posting on thefunded.com.

The term sheet provided to us was astonishing, the most rapacious I have seen in 20 years. The terms were far from even remotely resembling market: extreme liquidation preferences, antidilution ratchets, wiping out of the previous investors. Most unbelievably, an absolute requirement for the management team and Board to resign, to be replaced in their entirety at [their] sole discretion[edited].

How Blogerrific Can You Get?

Mr. Blodget, 35, gained fame among American investors after correctly predicting in 1998 that the share price of Amazon.com would soar to $400. But that fame turned to infamy as Amazon and many others among the Internet stocks he recommended plunged. Several companies that Mr. Blodget praised in published reports and television interviews, including Pets.com, a unit of IPET Holdings, and eToys, failed before ever turning a profit.

...Through all of 1999 and well into last year, Mr. Blodget advised investors to buy virtually every stock he covered. Boyishly handsome with a charmingly casual manner, he became a fixture on CNBC and in the financial press, making the case for companies that were losing lots of money selling diapers or dog food over the Internet.(New York Times, November 15, 2001)

When Henry Blodget left Merrill Lynch, this was his Wall Street epitaph in the New York Times. Blodget's departure came at at a point when everyone felt burnt by Internet companies, and they perceived him as a cheerleader. A quick perusal of the stories about his stock picks on theStreet.com reveals positivity on the likes of Yahoo, Amazon, and Priceline.com, all of whom produced profitable businesses to the tune of many billions in profits.

However, Henry Blodget, who edits the very poignant Silicon Alley Insider is credited with arguing TechCrunch at $100 million, which TechCrunch Founder Michael Arrington disputes in this interview on Charlie Rose.



Whose Rents are they Anyway?

AOL announced plans to buy social networking company, Bebo for $850 million giving it access to 40 million members worldwide and rich video content like the online production house that arose out of lonelygirl15 fame on YouTube. In fact, Avatar of WidgetsLab predicted the move made sense for AOL over a month ago. Zach Hurst of 1Dawg notes that values Bebo users at $21.25/user, and that facebook users would be $300 per person at the $15 billion valuation given by its Microsoft investment.

The facebook valuation has driven many associated investments, and thus more venture capital into social networking websites. Adonomics is a facebook only VC fund, widget valuation tool and marketplace for orphan widgets. The company publishes its theoretical valuations of the Top 100 widgets on facebook by users. According to its valuation, the Top 100 facebook applications are worth $1.2 billion and each instance of use is worth $27.09.

So, if facebook is worth $15 billion and the ecosystem that drives facebook usage is worth over $1.2 billion, what is the valuation of the ad networks that plan to use widgets as marketing tools and advertising vehicles? Gigya received $9.5 million this week and WidgetBox received a CEO from Hummer Winblad who helped it raise $14.5 million with several other firms.

The final answer to the question of how much value facebook users create, and for whom will be fascinating. It's interesting and important for investors and entrepreneurs alike to ask now which investments will deliver profits, and which shall be attrited.

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