The IVF Drip II - Regarding Valuation on Tech Companies in Singapore

Continuing on the session that I have facilitated last Saturday, I will focus on another aspect of the discussion that hinges on the valuation of companies. Valuation of technology companies can be difficult because of a few things. First of all, valuation is a science and art. When a technology company (and I will specify it to internet companies) is in the early stages of its evolution (seed stage to series A), the valuation is more or less an art, because there are many different types of risks at play from market to execution risk. If you take the other extreme, when a company is in the mature stage (mezzanine or pre-IPO), you can apply different financial models to decide if you have valued the company better. Ultimately, the question is pretty simple but hard to find a good answer: "What is the price of your start-up?" or "What are the assets and strengths of your company that provide incentive for investors and how much do you think that they are worth?" Of course, Internet companies have the added complexities at early stages because if you carefully examine all the recent successful internet companies in the web 2.0 or social media space, you will realize that the investors are betting on the intangibles more than the tangibles. However, in Asia, as usual, the context from the Silicon Valley technology business textbooks fails because the investors have a different view on how a company is valued. So, here are some of the points which I have discussed with the floor last Saturday (12 July 2008) in the Unconference 2008 organized by the E27 team:

• Don't just think analytics, but monetary conversion from the analytics: For the breakout session, I offered a few metrics for the Internet companies, namely (i) Number of users - which is a useless metric because you can't attach a value to it now, (ii) User Activity or Usage - knowing how many users use the site requires attention, (iii) Profile of Users and Market Segmentation, and (iv) Translation of analytics into monetary terms. To explain the four terms, I will use the virtual worlds example. For a while, I am a non-believer of virtual worlds investments. First of all, I know that there are 13.5 million users in Second Life. If you believe in the number of registered users (13.5M) and make an investment based on that assessment, you are in for a crash. I made a simple test by looking at number of active users for 24 hours, looking at every 15 minutes, and I realized that there are only about 100-200K active users on site (that's last year but this year may be different). That statistic tells you that the valuation of the company based on 13.5M users is too simplistic because there is a lack of user activity. Then the next question I ask is what the users are doing in Second Life. Yes, we know that they fly around the virtual world visiting beautiful Dell islands and buying beautiful ferrari cars with Linden dollars. Now the real part that helps in the valuation is the profile of the user. For example, here is an example how I will see that it's a worthwhile investment. For example, I know that there are many users in the Dell Island at 10pm (EST time) looking at computers. Is it a good opportunity to target advertising or adopt means of referral advertising with the users buying a new computer from Dell? Now the problem in Asia stretches this a bit more. Investors don't value by the intangibles. If you try the web 2.0 approach in Silicon Valley of building a large user database, you are in for a surprise. You may get away with it in China but not in other parts of Asia. The reason is that the investors in Singapore want to see a conversion of monetary terms. That's why standard textbook answers from Silicon Valley don't work in Singapore. For example, if you are a web 2.0 job site and you provide a US$3M valuation for your company, it follows that you have to be prepared to justify how much a client on your site is paying for the service and how each activity in the site is giving you how many dollars and cents. Remember you need to demonstrate profitability in order to attract investment. 
• Your valuation is not about growing users or content: That comes to my next point. Growing users and content are just necessary conditions for the investors to consider investment. The key to value your company lies in how the users makes use of your services, and how your clients work on them. Online advertising is the most direct source of revenue but it is also highly dependent on your site traffic. If your valuation of your company in Singapore is based on online advertising solely, you will begin to realize that the numbers are far too small for investors to bother about putting money. That reminds us of the "Why not me?" argument I put forth in the last article. I have seen investors pouring money onto travel search engines in China and India and my first thought is that this investor wants a large domestic market. It is important to examine the profile of your investors and how they have invested in the past. That information also can help you in determining what a reasonable valuation is for your company.
• Investors and Entrepreneurs have different benchmarks of valuation for a company and be careful: In some situations which I have not seen but heard, an investor will drag out the decision for investment and claim that the valuation is too high for them. Every investor will do that and hence the entrepreneur needs to know what is the lower and upper bound of how much your company is really worth. Now, there exist some situations where the investor draws you on valuation and then secretly build a competitive site. I have not observed such situations here, but when an investor is taking too much of your time, it is important that you have to be on the safe side. Now, the entrepreneurs in Singapore needs to put their valuation based on sales, because the second round investment strategy for most venture capitalists here is sales and marketing capital for the tech start-ups, and very little money to help them to enhance their technology. That's the problem with  some tech industries in Singapore and explains very well why it is impossible to build a series A biotech company here. If you notice the behaviour of most biotech companies, some of them go out and list in Australia without making a single cent of profit. As long as smart money is not available, the venture capitalists will value their investments based on sales.

Photo of the audience in my breakout session (Credits to E27 team)

---

 

Comments

[Gibson Tang]

1 point that stood out to me.
For example, if you are a web 2.0 job site, you provide a US$3M for your company.

Shouldn't it be
For example, if you are a web 2.0 job site, you provide a US$3M service for your company

[shen]

There is a great article by M Arrington @techcrunch - http://www.techcrunch.com/2008/06/23/modeling-the-real-market-value-of-social-networks/

I quote - "you have to consider the current monetization value of users when comparing social networks. Raw user numbers are pointless without it."

[weekee]

I think for second life, there is better metrics to used as it is easy to see the amount of money spend in the economy itself so there is definitely more metrics to use than registered users.

I agree on your point that monetizing analytics helps in valuation but in for web stuff, it appears to me that whoever can paint a nicer and more convincing picture helps more than actual sales forecast.

I wonder if you could also share that base on your experience, how many of the start up actually meet their "forecast" given in their business plan?