I did a talk with Bill Werde at Billboard’s FutureSound conference a few weeks ago. The entire talk is online (in two parts) here. If you go to 7:45 minutes in on the first video (embedded below) you will get to a conversation about Pandora and Spotify and the royalties negotiations they have with the record labels.
The specific issue we discussed was how can you expect the music industry to feel like they need to improve the economics of a relationship that allows a company to be worth billions of dollars. It’s a great point and one that came back to me when I read the Airbnb article in the New York Times yesterday. It was this comment by Janan New, executive director of the San Francisco Apartment Association, that struck me:
I believe that any company that claims that sort of worth [$2bn] should have the social responsibility to disclose what the laws are in the jurisdiction that they’re in. And if they’re not capable of that, then their worth isn’t that high.
This is the new angle of attack from incumbents who don’t want to see upstarts change their game. And it is a powerful one. Nobody is crying for you when you are worth billions. So be careful what you wish for and what you disclose.
We have a few companies that have kept their fundraising valuations private, at great difficulty and effort. They have done it for reasons like this. They believe it is nobody’s business, other than their own, how they have raised capital.
And that was part of my point in the Billboard talk. Spotify’s $3bn valuation and Airbnb’s $2bn valuation aren’t real valuations. Nobody bought their company for billions in cash. They are simply financings in which money traded hands on terms that spit out those big numbers.
Please excuse a deep dive on something a bit technical here. But I think it is important. When an investor like Fidelity puts tens of millions of cash into Spotify at a $3bn valuation, they are not buying publicly traded common stock that will go up and down with the value of the company. They are most likely (I don’t know the terms of the Spotify deal so I am guessing) buying a Preferred Stock that gives them a liquidation preference (their money back or possibly plus some guaranteed return) in the event the company is sold at or below the valuation of their investment. So they are buying a bond plus an option. They are highly confident they will get their money back and they are taking an out of the money option on the upside. And they are very long term holders so they can wait quite a while for the company to be worth a lot more than they paid. The $3bn valuation is nonsense. That’s not what they are betting on. They are betting that the company is worth at least its total liquidation preference, which is likely an order of magnitude less, and that it might be worth more than $3bn some day and possibility a lot more.
But of course the record label executives don’t care. And neither does a landlord association executive. They just look at the huge numbers and say “fuck that”. And I don’t blame them one bit. I would feel the same way if I were them.
Here’s my point. We, the tech/startup/VC world, are not doing ourselves any favours by bragging about the big valuations we are raising money at. We are in fact doing ourselves great harm. Because it makes us look like spoiled brats who are being fed with a silver spoon. Those inside these companies (Spotify, Airbnb, Square, Twitter, etc, etc) know that is not what is really going on. We know how hard it is to build something really new and different. It is a struggle and nothing comes easy. But it is important to realise how the broader world sees it. And they just see billions. And then you get the attacks that I mentioned above.
Honestly, there isn’t much we can do about it. The securities regulations make it almost impossible to hide the terms of financings. And the media pounces on these big financing valuations like a hyena on red meat. But it is worth taking the time to downplay the numbers around a financing and focus instead on what it means (more jobs, better products, financial stability). And maybe the media can help us out a bit too by being intellectually honest what a $3bn valuation really means. That would be really nice. But I am not counting on it.
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