Silicon Valley fears a Facebook IPO ripple effect on start-ups

5 Jun 2012

It’s strange. The Facebook IPO that should have been a momentous event in Silicon Valley history has so far been a disappointment. But that was two weeks ago and it’s only now that investors and start-ups are worried about a ripple effect.

Emails and blogs today flitting back and forth suggest things are about to get very hard for entrepreneurs trying to raise funds because of the poor-performing IPO.

What has gotten pulses racing today is an email from Y Combinator’s Paul Graham that warned how hard things are going to get. While it has been reported as a portent of bad times, it actually reads as good, down-to-earth advice for companies seeking equity.

Nevertheless, it seems the IPO of a company with a US$100bn valuation that failed to pop has brought an air of reality to the burgeoning tech scene. The party’s over and it’s back to work. For some it’s March 2000 all over again, for the optimists it’s still a bubble within a bubble that hasn’t yet gotten out of control.

No doubt forthcoming financial results from Apple, Google and Microsoft will get the juices flowing again and everyone will get back to business. But I argue Facebook’s IPO might have actually done some good rather than negated prospects for entrepreneurs hoping to get funding.

Dose of reality

There’s nothing wrong with a dose of reality. Maybe we’ve put an end to wild speculation for awhile.

“Which means it’s more important than ever to be flexible about the valuation you expect and the amount you want to raise (which, odd as it may seem, are connected),” Graham wrote.

Warning about the likelihood of down rounds in the post-Facebook IPO environment, Graham said: “The best solution is not to need money. The less you need investor money, (a) the more investors like you, in all markets, and (b) the less you’re harmed by bad markets.

“I often tell start-ups after raising money that they should act as if it’s the last they’re ever going to get. In the past that has been a useful heuristic, because doing that is the best way to ensure it’s easy to raise more. But if the funding market tanks, it’s going to be more than a heuristic.

“The start-ups that really get hosed are going to be the ones that have easy money built into the structure of their company: the ones that raise a lot on easy terms, and are then led thereby to spend a lot, and to pay little attention to profitability. That kind of start-up gets destroyed when markets tighten up. So don’t be that start-up,” he advised.

Challenges for venture capital

In fact with or without a Facebook IPO, the market for venture capital wasn’t quite as rosy as stories about Silicon Valley would have you believe. It’s difficult everywhere, especially in Europe, to raise venture capital and local funds have already been complaining about how thin funding is on the ground.

Venture capital firms are under pressure to build funds and Graham is quite correct in assuming that the poor performance of the Facebook IPO will make it harder for funds to attract investors.

In Ireland this year, a sharp fall-off in venture capital is expected. This was expected pre-Facebook IPO and no doubt the stock’s poor performance to date won’t be helpful.

Facebook’s future performance

However, is it too early to be writing off Facebook’s performance in the public markets? New York-based venture capitalist Fred Wilson from Union Square Ventures believes there are still fantastic returns to be had for investors and shareholders in the social network.

“Clearly Facebook is a premium company and commands a premium valuation and entrepreneurs should not expect to get 10x revenues and 25x EBITDA for their companies in a sale or an IPO,” Wilson blogged today.

“But even at half those numbers there are fantastic returns for investors and entrepreneurs to be had.

“If speculators are disappointed with the performance of the Facebook IPO it is because they had ridiculous expectations of what rational investors would pay. The market has put a premium valuation on a great company and we should be happy about all of that. I certainly am.”

Whatever happens, technology companies and innovation are the future. The stellar success of Facebook should not be the ultimate guide to success for the many different kinds of companies that make many different kinds of technology and science happen.

I’ll just call it a distraction for now.

John Kennedy is a journalist who served as editor of Silicon Republic for 17 years