The Truth About How A 12-Month Old Company Gets A $1 Billion Valuation

Slack CEO Stewart ButterfieldSlackSlack CEO Stewart Butterfield

One of Silicon Valley’s hottest young companies is Slack, the business messaging app that was valued at a jaw-dropping $US1.1 billion valuation in October,just 9months after it launched.

Zero to over $US1 billion in 9 months?

Even by Silicon Valley’s loose standards, that seems insane.

And now Slack CEO Stewart Butterfield has admitted that the valuation was based almost as much on speculation as it was on traditional metrics.

In an interview with Fortune, Butterfield explained, “There are fairly precise methods for putting a value on future cash flow given steady business,” but since Slack’s business is skyrocketing, not steady, he admitted, “We’re not in that position, obviously.”

The issue: Slack is growing at such a fast rate that it’s hard to come up with meaningful business projections. Since its launch in February when it claimed to have 15,000 daily active users, Slack has grown to have 365,000 users. That’s nearly 25X growth in just a year, all without any real spending on sales and marketing.

Slack claims to be adding $US1 million in annual recurring revenue (ARR) every month, with “near perfect” retention rates. ARR doesn’t mean actual revenue. But it’s a good indicator of a cloud software company’s health since it represents the value of the total subscription contracts expected to recur for the next 12 months. Based on those metrics, Slack would have made a little over $US12 million last year.

That amount of revenue doesn’t seem like enough to justify Slack’s billion-dollar valuation, but it does show that companies are willing to pay for its service. And that’s what the VCs are counting on.

“We’ve established that people would pay for us. Slack is being valued based on its ability to make money rather than something more speculative,” Butterfield told us in a previous interview.

Valuations are a tricky business, too, because they are based in part on how much money venture capitalists are willing to invest in exchange for how big of a chunk of the company they will own. In the end, if the investors and the company agree, that’s what the company is worth.

And it looks like investors were lining up to invest in Slack. Butterfield says he was initially trying to raise only $US100 million, but he saw so much interest that he ended up raising $US120 million, with $US200 million in commitments. It also probably helped that Butterfield is a well-known figure in the Valley, having sold his previous company, Flickr, to Yahoo for about $US35 million in 2005.

In Slack’s case, there was a bit of a leap here, too, apparently. Butterfield didn’t really need the money. But Butterfield saw that venture was relatively easy to raise right now, and having lived through the 2008 downturn, wanted to strike while he could. He also wanted Slack to be known as a $US1 billion company. His logic: Being in the “Billion Dollar Club” helps to acquire new customers and great talent.

“One billion is better than $US800 million because it’s the psychological threshold for potential customers, employees, and the press,” he told Fortune.

Yet still, it’s unclear if the app is just a trend or a real long-term business. Some companies are just leaving the space altogether. Basecamp, for example, dropped a business group chat app called Campfire from its product lineup in early 2014.

Even Butterfield seems to concede: when asked why Slack is so popular at a recent conference, he said, “I have no f — ing idea.”

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