How 11 Startups With Billion-Dollar Valuations Actually Make Money

Alexandra Wilkis Wilson Alexis Maybank Gilt Groupe

Photo: Modern Luxury Media via Flickr

Every month or two, another tech startup enters the billion-dollar club.News stories dutifully report the amount of the round and the names of the investors, along with the new valuation number.

But a lot of times, a more fundamental question is left unanswered: how do these companies make money?

It’s almost like if you have to ask, you’re too dumb to know. But that’s precisely the kind of thinking that created the dot-com bubble of the late 1990s.

So here are the answers: the business models of 10 tech companies who haven’t yet filed to go public but are reportedly valued over $1 billion — along with one company, Foursquare, that’s getting close to that number.

It’s a mix of straight e-commerce, transaction brokering, and advertising.

Foursquare is still experimenting, but will probably end up taking a cut of Groupon-like deals sold through the app

The check-in service has more than 10 million registered users, but it's free for users.

Foursquare doesn't charge merchants for setting up an account, either.

In June and July, Foursquare announced partnerships with a bunch of daily deal sites, including Groupon.

The idea is fairly straightforward: when you look for venues around you on Foursquare, it would tell you which one have a daily deal option open. If you buy that deal, Foursquare gets a cut.

Foursquare isn't valued at $1 billion yet, but its recent round in June valued the company at $600 million -- way up from $95 million last year -- so it's well on its way.

Spotify gives music away for free and upsells subscriptions.

Because it allows you to play any song on demand, Spotify pays a much higher per-song royalty to record companies and music publishers than radio services like Pandora (probably five times as much -- the exact rate is negotiated by each company). So the trick for Spotify is getting enough paying subscribers to cover these significant licensing fees.

Back in 2009, this was tough: Spotify earned only 11 million pounds, mostly from its 250,000 subscribers, but spent more than 18 million on licensing. Since then, its European subscriber base has topped 1 million, which may have put it in the black.

But the company entered the US with a very generous six-months-free plan, which could lead to another round of huge costs.

Spotify is funding its US expansion with a $100 million funding round it closed in June, which valued it around $1 billion.

Storm8 sells social games for the iPhone and other platforms.

This is an easy one: the company sells games for mobile phones. As of early June the company had 10 of the 25 top-grossing apps in Apple's App Store, including #1 iMobsters.

Earlier this month, sources told TechCrunch that the company was about to raise a whopping $300 million round at a $1 billion valuation.

Gilt Groupe buys clothing from wholesalers at a discount, then sells it at close to wholesale prices.

According to this Quora answer from clothing wholesaler Matt Carroll, Gilt hires buyers who approach clothing wholesalers whose fashions they like. Gilt agrees to take unsold inventory from these wholesalers, so the wholesalers are willing to sell it to them at a steep discount. Gilt then turns around and sells the clothes to its members in 'flash sales,' which have a higher conversion rate than most other forms of online commerce because members actually signed up to participate (they're qualified leads, basically).

Gilt makes gross margins of at least 50% on each sale. The company reportedly booked sales of more than $500 million last year.

In May, the company raised a round that valued it close to $1 billion.

Airbnb lets homeowners rent their places out for short times, then takes a 10% cut.

Pretty simple. The homeowner keeps 90% of the payment, and Airbnb takes the rest for helping to set up the deal.

Square takes a 2.75% cut of each sale made through its credit-card reader or mobile apps.

Square used to take an additional $0.15 per transaction, but dropped that fee in February. (It still charges that $0.15 fee, plus 3.5%, for transactions that are keyed in manually.)

The company is growing like wildfire -- in April it was processing $2 million in transactions per day, then passed $3 million in June. It's been looking for funding at a valuation between $1 billion and $2 billion.

Vente Privee is similar to Gilt Groupe -- it buys goods cheap and sells them for a profit.

All flash sales sites work essentially the same way, but Vente Privee was one of the first and has built massive scale. It's now got annual sales above $1 billion, and a valuation of $3 billion. Its founder Jacques-Antoine Granjon now wants to branch out into every possible kind of event sale -- concerts, travel, and so on -- and turn it into a $15 billion company.

LivingSocial gets a cut from the daily deal sales it sets up for merchants.

LivingSocial (like Groupon) is basically a form of advertising for small businesses. Businesses set up a special time-limited deal through LivingSocial to get customers in the store. LivingSocial takes a 30% to 35% cut of each sale from the deal -- that's less than Groupon's 50% cut.

The site is on track to pull $1 billion in revenue this year, and has been valued at $3.5 billion or so. CEO Tim O'Shaughnessy explained more about LivingSocial in his exclusive interview with Business Insider last February.

Dropbox gets users hooked with a free level of service, then charges for more storage.

It's a pretty classic freemium business model -- the first 2GB of storage are free, but if you need more you'll pay an annual subscription fee.

The company has been shopping around for funding at a valuation between $5 billion and $10 billion.

Twitter sells promoted trends and other products to advertisers, and charges search engines for access to its data.

Twitter's most successful product to date is Promoted Trends, which lets advertisers buy a trending topic for the day. The reported cost is $120,000. It also sells Promoted Accounts, which lets advertisers appear in users' 'Who To Follow' recommendations.

In addition, Twitter reportedly charges Microsoft and Google about $15 million a year each for access to its 'firehose' of real-time data, although Google recently declined to renew its contract and Microsoft may be considering dropping it as well.

Twitter started raising a new round in July at a $7 billion valuation, according to the Wall Street Journal.

Facebook sells ads and takes a 30% cut of purchases made through games.

It's not exactly a startup, but it hasn't filed to go public yet, so it makes the list.

Facebook sells ads that it places in front of its huge audience -- more than 700 million by latest estimates. The idea is that because Facebook knows so much about each user, it can target those ads more effectively than a lot of other Web sites.

Facebook is also beginning to take a cut of sales made through the site: it recently introduced Facebook Credits, through which it takes a 30% cut of purchases in games. The company is also reportedly building a mobile app platform with a payment system -- like Apple's App Store, only on multiple mobile phone platforms -- and says it sees opportunity in media (audio and video content) and e-commerce.

In January, reports estimated that Facebook would earn more than $1 billion on $4 billion in revenue this year -- that's up from an estimated $600 million on $2 billion in 2010. The company's shares are traded on private markets.

The latest sale, by early shareholder Interpublic, valued the company at $66.5 billion.

Now, find out how Google makes money, and other things you might not know about the tech industry.

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