26 Nov

Devaluations of Snapchat, Dropbox and Square highlight start-up pitfalls

This article by Renata Cooper originally appeared in Australian Financial Review.
Devaluations of Snapchat, Dropbox and Square highlight start-up pitfalls

For years, technology start-ups have been on an upward trajectory. Successes like Facebook, Whatsapp and Etsy inspired many to give their ideas a shot and investors the opportunity to fuel entrepreneurial dreams. It has made being a small business cool again.

However, recent devaluations of Snapchat, Dropbox and Square – some of the most highly valued tech start-ups – have sent tremors of concern through the industry and are likely to put the brakes on the fast pace.

Dropbox was told it couldn’t go public anywhere close to its last financing round’s valuation. Jack Dorsey’s Square filed a share prospectus worth $2 billion less than its last fundraising round, while Snapchat’s value was written down 25 per cent by Fidelity, one of its most high-profile investors.

Speculation is now rife whether this is the start of a domino effect that will eventually burst the private tech bubble, or if it is just a much-needed market correction. While Snapchat’s devaluation has been in the forefront of news, Fidelity also wrote down Dataminr, Zenefits and others investments. But Uber, also funded by Fidelity, held on to its $50 billion-plus valuation.

In April 2014, there was only one tech start-up valued  at more than $10 billion and 43 at more than $1 billion. Now, there are nine valued  at more than $10 billion and 125 at more than $1 billion, with Uber leading the charge. These unicorns will now be watched closer than ever.

Interestingly in Australia, all this news dropped just a week or so after SEEK co-founder Paul Bassat launched Australia’s biggest ever tech start-up fund – $200 million backed by James Packer and super funds. The start-up scene in Australia is robust and relatively young (especially compared with Silicon Valley) and recently, has had a spate of blue chips like AMP, NAB, Westpac and First State Super throwing support and money behind it. So it will be interesting to see what impact, if any, the devaluations will have on our shores.

As an angel investor, I agree with Fortune magazine’s observation that marking values of private companies is more art than science. Nothing is a certainty in this game. Just earlier this year, Fortune had also written a glowing report on why Snapchat is worth $19 billion or more. Things are a bit different now.

But it’s not all doom and gloom – especially for Australia. While we have long lamented being behind the US on trends, access to global markets, talent and so on, this time the delay works in our favour. Here’s what we can learn from Silicon Valley and avoid the same devaluations happening here.

Revenue: The reality for Snapchat, Dropbox and even Twitter is the challenge of turning large numbers of users into revenue streams. The momentum, online buzz, and investments that helped grow the brands and companies, will eventually have to generate revenue – for the business and for investors too.

New York Post quoted a Silicon Valley insider as saying that Snapchat was still struggling to figure out how to monetise its app and that the revenue model had not been clear from the start.

Popularity, a great idea, hype, engagement and growing user numbers – some of the fundamental reasons tech start-ups have become popular are all redundant if you can’t make money. Start-ups that have been focused on building their users numbers have to refocus and start pricing for profits.

Valuations are predominantly derived out of expectations of growth and revenue and offset against risks. Fidelity’s belief in Snapchat’s revenue generation is obviously less than what it thinks Uber can deliver. This could be Snapchat’s opportunity to reset with a better revenue model.

Culture and people: Recently, The Telegraph in London talked about how start-up culture was killing real entrepreneurship, with a generation of people not working hard enough to nurture their companies.

The author noted that even when true innovation happened, there was an increasing tendency not to attempt to create a business with a long-lasting plan, but instead to chuck it towards larger corporations in exchange for a handful of cash. And this was creating a culture where people were ignoring business realities.

CULTURE OF OWNERSHIP

People are important. Both Snapchat and Twitter had senior executives leaving recently. Any such exodus affects investor sentiment about the brand’s future performance.

Leaders of start-ups have to invest in people and focus on creating a culture of ownership that in turn helps build a sustainable company with longevity.

Corporate handbook: I’ve always maintained that successful corporations have been around for as long as they have due to processes, systems and a focus on basic business fundamentals. Most have risen to the top because of strong revenue and not the expectations of profits.

Among start-ups, there is a tendency to scorn at such frameworks as archaic and lacking the agility of a dynamic industry.

These processes and practices have to be established early on too. Harvard Business Review observes that entrepreneurs actually show their inability to switch to executive mode much earlier in the business development process than most people realise.

Maybe it is time we took a few pages out of corporate handbooks. After all, Henry Ford would never have become who he was if people weren’t willing to pay for a Model T.

It is a numbers game for all of us. This could be a much-needed correction for both investors and start-ups. We just need to buckle up, put our heads down and plough on ahead at more realistic speeds.

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